When income tax hits 60% you can mitigate the impact

Back in 2010, the Government introduced a Personal Allowance Income Limit, which was set at £100,000. Once someone’s annual income passed that figure, their personal allowance would start to reduce by £1 for every extra £2 of earnings. The Personal Allowance Income Limit has not so far been increased to reflect inflation, so remains at £100,000 for 2012-13.

The income range through which this relentless reduction in personal allowance takes effect is twice the allowance itself, £8,105 for 2012-13. So, the range currently runs from £100,000 up to £116,210, at which level the personal allowance has totally disappeared. The effect of this diminishing personal allowance is to add tax equivalent to half of the 40% higher rate, meaning an effective rate of 60% within that range.

So, is there any way that someone whose income falls within or above the tax-blighted range can avoid the 60% trap? Fortunately, yes. This is because, for the purposes of the Personal Allowance Income Limit, the measure of income applied is ‘adjusted net income’. Put simply, this is calculated by totting up an individual’s taxable income from every source and subtracting any disbursements that qualify for tax relief.

From 60% tax to 60% tax relief

Prominent among items deemed to reduce income for this purpose, are pension contributions made gross. If somebody earning more than £100,000 per annum pays into their pension plan a sum sufficient to reduce their adjusted net income to £100,000, their personal allowance will be restored to its normal level. This puts the boot on the other foot, giving an effective tax relief rate of 60%

The benefits of such action are not confined to those whose annual income is only just above the range over which the personal allowance reduces due to the Personal Allowance Income Limit. Comparable tax savings could be achieved where income is substantially higher than £116,210. Anyone for whom additional contributions to their pension plan would be a suitable strategy could make contributions to bring adjusted net income within the range or indeed right down to the charmed £100,000 figure.

Such higher earners would need to make sure that their total pension contribution did not breach either the Lifetime Allowance of £1.5 million or the Annual Allowance of £50,000, as this would have adverse tax implications. Anyone earning over £150,000 would have to use available ‘carry forward’ of Annual Allowance from prior years to cut their adjusted net income right down to £100,000. This can only be done while eligible unused amounts remain available for ‘carry forward’.

Mitigating the effects of the Personal Allowance Income Limit is just one of the options available to help ease the impact of taxation; please contact us if you would like to review your particular circumstances.