This content is for information and educational purposes only. It should not be taken as financial advice or investment advice. To receive tailored, regulated financial advice regarding your affairs please consult us here at Hanson Financial Services (financial advice in Liverpool).
The recent 2021 Autumn Budget ushered in a range of changes, marking the UK’s highest
tax burden in 70 years. From 7th April 2022, every worker will pay a new 1.25% Health and Social Care levy and investors (and business owners) face paying 1.25% more on their dividends. At the same time, costs are rising across the country. Inflation is expected to reach 4%
or more in the new year (twice the Bank of England’s target rate), and the price of energy has skyrocketed as supply chain issues worsen in the approach to Christmas.
In light of this, it is little wonder that households across the UK are wondering how to put more of their hard-earned money back into their pockets. One of the best ways to do this is through tax-efficient planning
. Below, we explore what options are available for people facing the 40% Higher Rate. We hope you find this content useful and invite you to get in touch if you’d like to discuss your financial plan with us.
Rising Higher Rate taxpayers
As many as 10% of earners could be paying the 40% Higher Rate in the coming years if wage growth continues along its current path. Lower earners also face a higher tax bill in this period, after the Chancellor announced that the tax-free personal allowance (currently set at £12,570) will be frozen for five years, potentially bringing in another £20bn to the treasury. The £50,270 Higher Rate threshold has also been frozen.
This clever strategy is widely referred to as “stealth tax” since workers rarely
notice the impact of frozen allowances on their payslips. Moreover, the Chancellor has announced that the “public sector pay freeze” has been scrapped and the national minimum wage will be raised in April (up from £8.91 to £9.50
per hour for workers aged over 23). Whilst this may help many workers with the rising cost of living, it is also likely to push many people into a higher tax bracket.
The power of pensions
One of the best ways to save on Higher Rate tax – and save towards your retirement – is to use your pension
. In 2021-22, you can put up to £40,000 into your pension(s) each tax year (or, up to 100% of your earnings – whichever is lower). Your contributions receive “tax relief” – meaning that the money you would have paid to the government in tax, instead goes to your pension. So, if a Basic Rate taxpayer puts 80p into her pension, the government will “top it up” by 20% so it totals £1. For someone on the Higher Rate, the “top- up” will be 40%. This means that it “costs” you 60p to put a total of £1 into your pension.
Suppose you earn £70,000 per year. This means that £12,570 of your salary is tax-free under your personal allowance. £12,571 to £50,270 will be subject to the Basic Rate (20%). The rest (£19,730), however, will be taxed at 40% unless you take further action. If you can afford to, then one idea is to put some of it – even most – into your pension. Not only does this help shield up to £19,730 from 40% tax, but up to £7,892 in tax savings could be put back into your pocket via the government tax relief on your contributions.
You need to think carefully about this, of course. Any money you put into your pension(s) will be locked away until you turn 55 (expected to rise to 57 in the future). As such, make sure other key parts of your financial plan are in place first. For example, having 3-6 months in living costs saved in an “emergency buffer” account will be a high priority for many households.
Options for dividend receivers
Business owners and investors who receive a significant portion of their income from dividends may have some other options. Remember, in 2021-22 you can earn up to £2,000 each tax year in dividends before facing tax. The tax rates on dividends are lower than those on income, and this will continue to be the case in April 2022 when the former rises (although the gap will close somewhat). For instance, Basic Rate taxpayers face 20% on their salary, yet any dividends they receive outside of their allowance faces a 7.5% in the current tax year. For those on the Higher Rate, the figures are 40% and 32.5%, respectively.
One possible option for business owners, therefore, is to consider raising your dividend income (e.g. taking more company profits) in exchange for any planned salary increases which might take you further into the Higher Rate. However, you do need to plan this carefully – ideally with professional help/advice. If the company performs badly in the years ahead (perhaps due to a new COVID-19 lockdown), then a loss in profits could affect your dividend income. Moreover, bear in mind that lenders may not lend you as much money as you would like if you lower your salary. Consider speaking with a financial adviser if you want to explore this area.
Conclusion & invitation
There are a variety of ways you can protect yourself from higher rate tax, depending on your circumstances. However, it’s important to make the right financial decisions for you, and, with that in mind, seeking professional advice can be the best way forward.
Are you interested in talking to a financial adviser about your financial planning or pension needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.