Groucho Marx once famously said he refused to join a club that would have him as a member. However, some individuals are being automatically enrolled as members of an exclusive club, known as the 60 per cent tax rate club.
The recent focus of the Chancellor of the Exchequer has been to increase the personal allowance, removing more people from liability to tax and increasing the take home pay of others.
However, for those with adjusted income in a band over £100,000 the personal allowance is gradually withdrawn, resulting in an effective marginal income tax rate of 60 per cent in that band.
Why is that the case?
For the current tax year the personal allowance is £11,500.
Where an individual has an adjusted net income between £100,000 and £123,000, the personal allowance is reduced by £1 for every £2 of the excess over £100,000. This produces an effective marginal rate of 60 per cent, the personal allowance being withdrawn fully where adjusted income exceeds £123,000. In fact, those in employment and the self-employed will actually be suffering a combined tax rate of 62 per cent when national insurance is taken into account.
What can be done?
Adjusted net income is all taxable income less certain allowances. So what sort of things can be considered to reduce the impact of the 60 per cent rate?
1. Deferring income
Where it is within your control, consider the timing of the payment of one off items such as bonuses or special dividends to smooth income between tax years.
2. Replace taxable with non-taxable income
This could be as simple as holding investments through an ISA as opposed to directly, or more complex salary sacrifice arrangements replacing cash salary with tax free or tax favoured benefits in kind. Although changes to the tax rules from 6 April 2017 have severely curtailed the types of benefits which qualify for tax favoured treatment via salary sacrifice, some limited options remain and it is still worth considering them.
3. Transfer assets between spouses or civil partners
If you are married or in a civil partnership, consider transferring income bearing assets to your spouse or civil partner, provided of course they are not, or would not themselves become, a member of the 60 per cent club.
4. Pension contributions
Pension contributions are deductible in arriving at adjusted net income. So, where adjusted income remains at or above £100,000 after the contribution, a gross pension contribution of £10,000 by someone within the club could actually have a net cost of only £4,000; a significant saving and probably the most commonly used means of reducing the effect of the 60 per cent rate. Using salary sacrifice arrangements to make pension contributions adds to the saving by avoiding the national insurance charges that would otherwise arise on the income used to make contributions.
5. Gift aid
Similar to pension contributions, payments under gift aid qualify as allowable deductions in arriving at adjusted net income. A net gift aid payment of £800 could reduce the tax bill of a club member by £400.
You are not alone
The Institute of Fiscal Studies estimates that around 800,000 people will pay the 60 per cent tax rate in 2017/18, and this will rise to an estimated 1,000,000 people in 2018/19. Don’t drift inadvertently into a club that Groucho wouldn’t have wanted to join. A little planning could go a long way in reducing the impact.