Investing is far from being just a numbers game, and in fact it is investors’ emotions that are very often their undoing in panic-stricken times, as this behavioural finance expert explains.
Higher-earners are despairing of the brutal tax charges they are increasingly hit with, and while reforms may be afoot, there is a lot the savvy could be doing right now to mitigate them. Here, wealth management experts from our panel offer their tips for beating the top-rate tax trap as it currently stands.
Preservation, growth and tax minimisation are the three pillars of a sound wealth management plan and the last element has recently become a really hot topic for the UK’s highest-paid.
Many of the users of our service are top-earners, and these often include business-owners and self-employed contractors, as well as professionals like lawyers and doctors. The Institute for Fiscal Studies recently highlighted what they have been telling us for some time: quirks of the tax system often mean earning over £100,000 a year ceases to make financial sense due to a punitive 60% tax rate kicking in (an effective 62% once National Insurance contributions are taken into account).
As Roger Clark, Head of Wealth Management at Brown Shipley, explains: “It is a strange quirk of the tax system to have marginal income tax rates of 20%, 40%, then 60%, then falling back to 40% before finally rising to 45% again once income reaches £150,000.”
“The effective rate of 60% applies because once income reaches £100,000 then income above that figure results in the loss of the personal allowance on a 2-for-1 basis. At income above £125,000, the personal allowance is zero and so the tax rate reduces back down to 40% until income exceeds £150,000 at which point the 45% rate applies.”
This issue has been brewing since this tapering was introduced in 2010. While the personal allowance has risen, the threshold has not tracked inflation, meaning that more and more people with a taxable income of over £100,000 are falling into the “personal allowance trap” completely unawares. Some 360,000 people are currently affected, but this number is predicted to swell dramatically as wages continue to rise.
Some 360,000 people are currently affected, but this number is predicted to swell dramatically as wages continue to rise
Tax considerations are increasing curtailing careers – or at least causing a lot of stress to busy professionals. Doctors have been hit extra hard by steep tax bills stemming from a combination of high earnings and good NHS pensions which has pushed three-quarters of GPs to cut their hour (an issue thought to have pushed the government towards reforming the tapering system for higher-earners). But of course, it’s hard for anyone to get excited about new opportunities when your net earnings may be only 38 pence in the pound.
The fact that this has seen many senior doctors cut back on work prompted the government to announce a review in January and an announcement is expected in the March budget statement – and any tax cuts will of course benefit all higher-earners. However, they should not wait for possible cuts to be announced to get proactive. There are several intelligent wealth management strategies you can look to pursue right now that will allow you to maximise your earnings, and keep more out of the taxman’s reach. Many may present wider benefits for your financial plan too.
There are several intelligent wealth management strategies you can look to pursue right now that will allow you to maximise your earnings, and keep more out of the taxman’s reach. Many may present wider benefits for your financial plan too
Tax mitigation is often not given the attention it deserves. It’s certainly as important as capital growth and protection. In fact, such is its impact that arguably your tax position should be a lens through which you see all your financial affairs. A professional adviser will bring this view along with an arsenal of strategies to maximise your overall wealth. See which wealth managers are best suited to you via our 3-minute search.
Henry Denne, Head of Financial Planning at Punter Southall Wealth, advises as a first easy piece of fiscal “house-keeping” that all higher-earners ensure they are using all available and appropriate tax-efficient company benefits, such as Cycle to Work schemes and Childcare Vouchers.
Also essential, says Clark, are tax-efficient wrappers to house investment income which might otherwise be liable to income tax, such as Individual Savings Accounts (ISAs) and the use of tax deferral vehicles like investment bonds.
Making higher pension contributions may be an effective strategy for many higher-earners, notes Clark: “Pension contributions which reduce income in the band £100,000 – £125,000 will secure an effective tax relief of 60%”.
This means money you set aside for later restores lost personal allowance now, Denne explains. However, you should be aware of breaching the Lifetime Allowance (LTA) for contributions, which is £1.073 million for the 2020/21 tax year (£1.055 million for 2019/20). Alternative ways to save and hold investments, like ISAs, may need to be deployed if you are near the LTA threshold.
Denne also advises those who are married or in a civil partnership to ensure that they are assigning ownership in the most efficient way. “Think about which of you owns which income-producing assets such as shares and rental property, and consider transferring them to the partner with the lowest overall income level,” he says.
Think about which of you owns which income-producing assets such as shares and rental property, and consider transferring them to the partner with the lowest overall income level
Higher-earners should also be aware of the power of timing in trimming tax bills, along with the form in which income is taken. “It may be possible to control the timing of the receipt of income, for example dividends, pensions or bonuses,” explains David Goodfellow, Head of UK Financial Planning at Canaccord Genuity Wealth Management. “For future years, income may be reduced by replacing taxable income streams with tax-free returns from tax-efficient investments or investing for capital growth rather than income. There is always some planning to be done.”
For future years, income may be reduced by replacing taxable income streams with tax-free returns from tax-efficient investments or investing for capital growth rather than income.There is always some planning to be done
As a final illustration of how clever financial planning can be beneficial in multi-faceted ways, Denne highlights the role of charitable giving: “This is also an income reducer, thereby lowering your taxable income. So, supporting your favourite charity can be both philanthropic and tax-efficient.”
The tax charges the highest earners face can be brutal, but the good news is that you don’t just need to take the hit, or even worse curtail your career to avoid them until such time as the government alters the tapering regime.
Now you are aware of how the “personal allowance” tax trap arises for higher-earners, you can take action to keep your tax bill to the lowest level possibly – all perfectly legitimately and as part of an overall financial plan likely to bring manifold other benefits too.
The tax charges the highest earners face can be brutal, but the good news is that you don’t just need to take the hit, or even worse curtail your career to avoid them until such time as the government alters the tapering regime
As we have briefly explained, there a number of possible strategies affluent individuals can pursue. However, taking professional advice is always essential as the rules around tax and pensions can be very complex – and that’s without ensuring your investment portfolio matches your profile and objectives as they change over time. Ensure that you speak to a reputable adviser at a leading firm by meeting one through our fast, free and objective matching service. The rewards of proper tax planning can be huge, but the penalties for getting things can be severe.