When Jeremy Hunt delivered his first Autumn Statement as chancellor on 17 November – seeking to steady the ship in the wake of the market turmoil unleashed by Liz Truss and Kwasi Kwarteng’s heavy-borrowing, tax-slashing mini-Budget – he reduced the threshold at which people begin to pay the 45p top rate of income tax from £150,000 to £125,140.
Intended to boost Treasury coffers with an injection of a further £420m annually at a time when the British economy is in recovery mode, the decision meant pulling another 232,000 people into the country’s highest tax band.
The changes he announced then are now due to come into effect from the start of the new financial year on Thursday 6 April.
It means that anyone earning a salary of between £150,000 and £125,140 will be drawn into the 45 per cent higher bracket for the first time, costing them an average of approximately £621 more per year each, according to The Daily Telegraph.
Mr Hunt also announced in November that the current freeze on the tax-free personal allowance of £12,570, which was first imposed in 2021, would be extended to 2028.
This is bad news for anyone earning between £100,000 and £125,140 because it means they risk being sucked into a 60 per cent “tax trap” or “sinkhole” that forces them to pay 40 per cent tax on any earnings beyond the £100,000 threshold while another 20 per cent is eaten away by the gradual tapering off of the tax-free allowance (£1 is lost from the allowance for every £2 earned north of £100,000).
High earners may be seeking ways to shield their capital from such traps and, according to the experts, there are a number of approaches they can consider.
Make a pension contribution
One of the most straightforward strategies to avoid being drawn into the above tax trap is for an individual to make a contribution to their pension pot to take their earnings back down below the £100,000 mark while providing a boost to their retirement fund at the same stroke.
“You would need to make a payment of £8,000 into your pension, which HMRC would automatically top up by £2,000 due to tax relief on pension contributions, resulting in a gross contribution into your pension of £10,000,” explains Harry Donoghue, an associate financial adviser at DipPFS.
“This has the effect of reducing your net adjusted income below the £100,000 threshold, which means that you have beaten the 60 per cent tax trap.
“So, not only have you gained £2,000 in tax relief straight into your pension, but you’ve also saved the same again by reclaiming your personal allowance. Furthermore, higher-rate tax relief can then be reclaimed on your tax return to bring the total net cost of the pension contribution to just £4,000.”
Up to £40,000 per year can be saved into a pension tax-free annually, with Mr Hunt moving just last month to drop the lifetime allowance cap on tax-free pensions savings in his first Spring Statement.
Explore workplace benefits
To achieve the same end, you could also opt to exchange a portion of your salary for an alternative benefit from your employer, such as a direct pension contribution, a strategy known as “salary sacrifice”.
Other workplace benefits like childcare vouchers or car finance schemes could also be employed in this way to keep you below the threshold of the upper tax brackets.
Make a charitable donation
Donating to worthy causes, either through GiftAid or by Payroll Giving via your employer, is another way to reduce the amount of your income liable for tax.
Gift Aid allows charities to claim the basic income tax rate on top of the value of your donation (25p for every £1 given) but there is also a specific advantage for higher rate taxpayers, according to Ridgefield Consulting.
“The charity is still able to receive the basic income tax rate in addition to your donation, however you further benefit by being able to extend your basic income tax rate by the difference between your tax rate and the basic income tax rate of the amount you donated,” the firm explains.
“To illustrate: if you are a higher rate taxpayer paying 40 per cent income tax and you donate £1,000 to a charity or CASC [community amateur sports club] via Gift Aid, the charity receives £1,250. You receive 20 per cent of £1,250 as tax relief because 20 per cent is the difference between your tax rate and the basic income tax rate.
“The tax relief is given to you by way of extending your basic income tax rate. This means that whilst the current threshold for the basic income tax rate is £50,270, by donating to a charity or CASC by Gift Aid, you can earn up to £50,520 and only pay the 20 per cent income tax rate.”
You can find out more about tax relief when donating to charity via the HMRC website.
Transfer assets to a partner
Husbands and wives who transfer assets between each other are exempt from capital gains tax when they do so, so if a partner is in a lower tax band, moving an asset into their name could potentially yield a significant tax saving.
This is worth considering given that dividends are taxed at 39.35 per cent for additional rate payers but at just 8.75 per cent for basic rate payers, as The Telegraph points out.
Open an ISA
Taxpayers paying the basic rate can earn £1,000 in interest on their savings tax-free but, for higher earners, the allowance is only half of that and for 45 per cent taxpayers the aforementioned personal savings allowance disappears altogether, meaning anyone making a deposit of £20,000 would be liable for £360 in tax.
Instead, that £20,000 could be placed in an Individual Savings Account (ISA) to reduce the tax burden because any income earned in an ISA is free from both dividend tax and capital gains tax.
Move payments forward
Bringing forward scheduled bonuses and dividends before the end of the tax year – admittedly a short deadline at this late stage –would mean receiving them before Mr Hunt’s changes come into effect, potentially helping you beat the tax trap by staying below the threshold come 6 April.
Invest
Venture capital trusts and initiatives like the Enterprise Investment Scheme supporting growing businesses both offer tax relief of up to 30 per cent (provided you hold onto them for five or three years respectively) while the Seed Enterprise Investment Scheme offers 50 per cent relief and therefore could be an alternative approach for those inclined to take a risk.
However, this strategy is not without its pitfalls and is not necessarily right for everyone.
You would be well advised to speak to a professional financial adviser before pursuing such a course.
