High earners and planning for the 45% and 60% tax rates

Summary

With a 45% additional rate for taxable income over £150,000 and an effective rate of 60% for “adjusted net income” between £100,000 and £125,000 through the reduction of the personal allowance by £1 for every £2 over £100,000, tax planning strategies will be of  significant interest to those affected by these high charges.

Facts and analysis

  • The rate of tax, known as the additional rate, payable on an individual’s taxable income (total income less allowable deductions) in excess of £150,000 is 45%. 
  • Where an individual’s “adjusted net income” exceeds £100,000 the level of the personal allowance is reduced by £1 for each £2 over £100,000 until it reaches zero. Adjusted net income is, broadly speaking, total income less specified deductions. The most important deductions are: contributions (gross amount) to registered pension schemes; “grossed up” gift aid contributions; and trading losses. If someone has adjusted net income of £110,000 the tax generated by the additional £10,000 in excess of £100,000 is calculated as follows:

£10,000 @ 40%  

£4,000  

Additional £5,000* brought into tax @ 40% 

£2,000  

Total tax   

£6,000  

Effective tax rate on £10,000

60%

*Personal allowance cut by £5,000 (from £10,000 to £5,000) i.e. £1 for every £2 of income above £100,000.

Dividends in excess of the £2,000 dividend allowance received by individuals are taxed, according to the tax band in which they fall, as follows:

Basic rate band  

7.5% 

Higher rate band 

32.5% 

Additional rate band 

38.1%

Next steps

Much of the planning to avoid the 45% additional rate and the effective 60% rate are founded on strategies that have been valid for some time in order to avoid 40% tax. It is thought that 45% and 60% rates will encourage many more to plan to keep tax to a minimum. The following list is not exhaustive but focuses on some of the potentially most widely applicable planning strategies.

  • Subject to being happy with the appropriateness of the investment portfolio (and in particular, the degree of risk being assumed), consideration could be given to investing for capital growth (taxed at 20% for higher rate taxpayers, after the annual exemption) rather than income (taxed at 40% or 45% or, effectively, 60%). Of course, tax should not be the sole determinant of an investment planning strategy.
  • While the lower capital gains tax rate would lead towards a collective investment rather than an insurance-based investment bond, bonds may well continue to represent a more tax attractive home for reinvested income in excess of the dividend allowance/personal savings allowance. Inside a UK life fund, dividend income would bear no further tax and other income would be subject (broadly speaking) to a 20% tax rate. There would be a 20% tax credit when a chargeable event gain was realised and, of course, tax effective withdrawals using the “5% rule” would be possible.
  • There are a number of issues to take into account in determining the most efficient tax wrapper for a particular portfolio. The balance between income and gains on the portfolio in question will be a particularly important one as well as the availability of the dividend and personal savings allowance.
  • The attraction of the tax-free investment growth and income secured inside an ISA will increase for people suffering 45% tax on income. The ISA annual contribution limit is currently £20,000 for 2020/21.
  • Clearly there is little action that a taxpayer can take to secure their personal allowance if they enjoy sizeable earned income. However, for those with investment income which causes their gross income to be just over the £100,000 threshold, they could consider reinvesting into capital growth oriented investments, investments that defer tax (eg. investment bonds) or investments that produce tax-free income (e.g. ISAs). They might also consider making a contribution to a registered pension scheme (subject to the annual allowance, tapered annual allowance or money purchase annual allowance). Clearly the investment risks need to be considered as do the capital gains tax implications on reinvestment.
  • Couples may consider ensuring that they split their investments between them to ensure maximum use of their allowances and lower tax rates. Those who own their own business could also consider the payment (to both) of income through salary, dividend or profit share. The opportunities for the two latter routes have remained for companies and partnerships respectively following the Government’s decision not to (at least for now) introduce legislation to counter this form of income shifting. However, earlier rules on what constitutes an appropriate commercial arrangement must still be considered, and you should get advice from your professional advisers.
  • For those who are subject to these high rates of tax, there will be a strong appetite for considering appropriate tax planning strategies to minimise tax and increase the returns on their investments.

Important information

This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2020. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.