This April you could be one of the additional rate taxpayers. In the past, you might have thought you’d be celebrating that development but not necessarily when you find out how much worse off you could be. Sarah Coles of Hargreaves Lansdown offers some tips on how to legitimately pay less tax and get more out of your earnings.
- The additional rate tax threshold will fall from £150,000 to £125,140 in April
- The move will mean around 232,000 extra additional rate taxpayers – taking the total to 792,000, according to HMRC
- Those people earning between £125,140 and £150,000 will be £621 worse off on average in the coming tax year. Those earning over £150,000 will be an average of £1,256 worse off
- That’s just the tax on income. They’ll also pay a higher rate of tax on dividends.
“If you’re an average earner, you’d be forgiven for thinking that becoming an additional rate taxpayer would be a nice problem to have,” says Sarah Coles, head of personal finance, Hargreaves Lansdown.
“However,” she says, “for those dragged into the 45p rate when the threshold is cut in April, there’s going to be nothing nice about the problems they face.”
Hundreds of thousands of people will be wrestling with higher tax bills, because being an additional rate taxpayer isn’t the exclusive club it once was – with more than three-quarters of a million people paying 45p tax, according to a Hargreaves Lansdown report.
If you tend to get a bonus, especially if you run your own business, you may have the flexibility to receive a bonus in the current tax year, where more of it is taxed at a lower rate.Sarah Coles, head of personal finance, Hargreaves Lansdown
Are there ways you can cut the additional rate tax amount you pay?
✂️Coles offers her tips here:
- Think about bringing any income forward to the current tax year. If you receive some of your income as profits from self-employment you can make sure your billing is up to date, so as much of your income as possible is made in the current tax year. If you receive some of your income from a pension in drawdown, you can bring some of it forward, and if you tend to get a bonus, especially if you run your own business, you may have the flexibility to receive a bonus in the current tax year, where more of it is taxed at a lower rate.
- If you’re married or in a civil partnership and your partner pays a lower rate of tax, you can transfer income-producing assets into their name, so you both take advantage of your allowances, and then the rest is taxed at their marginal rate rather than yours.
- Shelter as much of your income-paying assets in ISAs as possible. Income tax rates are usually higher than capital gains tax rates, so it’s worth prioritising sheltering those. If you hold income-paying shares or funds outside an ISA, you can use the Bed and ISA process, to move them into the tax shelter.
- Take dividends before the end of the tax year. If you pay yourself in part through dividends, you can take them before the end of the tax year – as long as it doesn’t push you over the threshold. Not only do you get a higher allowance this side of the tax year (£2,000 compared to £1,000 from April 6), but you also pay 33.75% on the excess as a higher rate taxpayer – instead of 39.35% as an additional rate taxpayer.
- Consider the timing of any additional pension contributions. You can carry forward any unused annual pensions allowance from the previous three tax years. If you’re set to change tax bands, consider whether it’s best to do it in this tax year, or in the next tax year when you could get 45% tax relief instead of 40%.
- In the next tax year, consider sacrificing more salary into your pension. If your workplace (or umbrella company) runs a salary sacrifice scheme, you can agree to give up some salary in return for pension contributions. If you pay additional rate tax, then on your last £1 of earnings you’ll face income tax at 45% plus national insurance at 2%, so you’ll take home 53p. If you sacrifice it into your pension instead, you’ll get the full £1. Some employers will pass on some of their national insurance saving too.
- Consider your cash ISA. This will depend on whether you have used your ISA allowance on investments, but if not, you can move savings into a cash ISA. When you become an additional rate taxpayer you lose your personal savings allowance overnight and pay 45% on your interest, so you’re better off in a competitive cash ISA than the equivalent savings account.
- Consider whether a Venture Capital Trust or Enterprise Investment Scheme meet your needs. These aren’t right for everyone, because they are very high risk so they should only ever be considered as a small part of a large and diverse portfolio. However, if you use these schemes you can get 30% income tax relief on the amount you invest – which will reduce your overall tax bill.