It has recently been reported that over half a million taxpayers paid a marginal income tax rate of 60% in 2022/23, a rise of 23% from the previous year. This marginal rate applies when an individual’s adjusted net income falls between £100,000 and £125,140, where every £2 of income over £100,000 reduces the £12,570 personal allowance by £1, such that it is fully eroded at £125,140.

Planning to Mitigate the Problem

The definition of “adjusted net income” is the individual’s total taxable income minus personal pension payments and charitable payments under Gift Aid. Such payments can effectively save income tax at 60%. For example, an £80 payment to charity under Gift Aid is grossed up to £100, reducing the taxpayer’s income by £100, thus saving £60 tax where the individual’s income is between £100,000 and £125,140. If an individual’s total income is projected to be £105,000 for 2024/25, they could consider making an additional pension contribution of £4,000 before 5 April 2025, which would reduce their income to £100,000, thereby restoring their £12,570 personal allowance.

Such planning is also effective for those caught by the high income child benefit clawback charge (HICBC). This charge claws back child benefit by 1% for every £200 of adjusted net income between £60,000 and £80,000.

Salary Sacrifice Arrangements Can Also Be Effective

Another way to mitigate the effects of the personal allowance restriction and the HICBC is to agree with your employer to forgo some of your salary, pay rise, or bonus in exchange for an additional employer pension contribution or an electric company car. For example, an employee on £96,000 a year might be entitled to a £10,000 bonus. They could agree with their employer to have £6,000 of the bonus paid into their pension (tax-free, provided the £60,000 pension annual allowance isn’t exceeded), with the remainder of the bonus keeping them just at £100,000 and retaining their personal allowance.

Sacrificing salary for an electric company car isn’t quite as tax-efficient, as the employee would currently be taxed on 2% of the list price instead of the salary foregone. On a £50,000 electric car, this would just be a £1,000 taxable benefit in kind, which for a 40% taxpayer would mean £400 income tax.

The employing company would obtain a tax deduction for the cost of providing the benefit and would also save on employer’s national insurance. So, it’s a win-win situation.