If you (or your partner) pay the 40% higher rate on income, then it helps to have a robust tax plan to retain as much of your hard-earned money as possible.
Tax planning for higher earners can result in useful savings - helping you plan for retirement and protecting your assets from inheritance tax. You can also keep more of your investment returns.
Below, our financial planners offer some key insights for higher rate taxpayers in the 2023-24 tax year. Please contact us to explore these ideas and information further in light of your own goals and situation.
The income tax system - a brief overview
It helps to have a clear picture of the broader UK tax system before focusing on how to mitigate the impact of the higher rate on your finances.
Most UK taxpayers are entitled to a tax-free personal allowance of £12,570. After this, the 20% basic rate applies to your income until it exceeds £50,271.
This is when the 40% higher rate comes into force. This continues until your income goes over £125,140. At this point, you start to pay the 45% additional rate.
These tax bands are applied to individuals, not households. So, suppose there are two households - Household A and Household B - to see how this works.
Household A has two adults working full-time. One person earns £60,000 and the other £40,000. Here, the first person is subject to the 40% higher rate. The second person is not.
Household B also has two full-time workers living there. However, in this case, both people earn £50,000. Each person only pays the 20% basic rate, as they are under the £50,271 threshold for the 40% higher rate.
Why the higher rate matters
Whilst earning above the higher rate is certainly nice for your income, it can have wider repercussions for your financial planning, which need to be carefully considered.
For instance, take the personal savings allowance (PSA). In 2023-24, a basic rate taxpayer can earn up to £1,000 in interest outside of an ISA without paying tax. For an individual on the higher rate, however, the tax-free limit is £500.
Another interesting case is Tax-Free Childcare, where you may be entitled to up to £2,000 per year to help raise a child under 11 years old. For every £100 you earn over £50,000, however, you need to pay back 1% of your benefit entitlement.
For instance, if you earn £55,000 a year then you need to pay back half . At £60,000, your tax-free childcare entitlement is effectively eliminated.
The higher rate also impacts how much tax you pay on dividends and capital gains. For dividends, the basic and higher rates are 8.75% and 33.75%, respectively.
For capital gains tax (CGT), the basic rate is 18% on gains from residential property and 10% on gains from other assets. For the higher rate taxpayer, the rate is 28% and 20%, respectively.
Your income tax band also influences how much pension tax relief you can claim on contributions. A basic rate taxpayer can claim 20%. A higher rate taxpayer can claim 40%. This means it “costs” the former 80p to put £1 into a pension. For the latter, it “costs” 60p.
How can I save tax as a higher Rate taxpayer?
As you can see, there is a host of complex rules to take into account as a higher rate taxpayer. What should you do? It depends on your goals and your circumstances.
For instance, suppose you are in your 20s, you earn £65,000 per year and your main goal is to gather a deposit for a mortgage. You do not have any children.
You would need to be mindful of the lower tax-free personal savings allowance (£500) compared to a basic rate taxpayer when building up your savings.
With many easy-access accounts now offering 3.3%, it may only take around £14,000 in cash savings for the interest to start breaching £500. So, this taxpayer would likely need to consider additional options to protect his interest and other investment returns from tax.
Alternatively, consider a higher rate taxpayer in his early 60s.
His priorities are to save more for retirement and to pay off the rest of his mortgage. One option he could explore is a “salary sacrifice” with his employer.
Here, the taxpayer takes a modest pay cut in exchange for more pension contributions from his employer. This is often more tax efficient than the taxpayer increasing his own contributions, since it also means paying no more on National Insurance and income tax.
One common strategy for higher rate taxpayers to explore is asset transfers between spouses (or civil partners). In 2023-24, this can be done tax-free and could allow your household to maximise each person’s tax-free allowances.
For example, suppose you have fully used your £20,000 ISA allowance for the 2023-24 tax year, but your spouse has not. By transferring ownership of certain investments to them, they could then use the “bed and ISA” approach to put the shares into their ISA.