Do you really need to pay higher rate tax?

While most people will agree that we all have to pay tax simply to keep the country running, most of us would be happier if we could find a way to persuade the taxman to take a little less of our hard earned cash.

However, there is a simple way to for most of us to pay less tax. It is perfectly legal, and there is no need to suddenly take up residence overseas or restructure your earnings through dubious companies based in far-flung island tax havens. All it takes is a little forward planning and making careful tactical use of your pension.

Understanding thresholds

The key to cutting your tax is to understand tax thresholds.  Most of us are concerned with two thresholds, the personal allowance threshold, the point at which we start paying income tax, and the higher rate income tax threshold, where tax starts to be charged at 40%.

There is also an additional rate threshold for those earning over £150,000 which sees them paying 45% tax, but for most of us this is sadly only of academic interest.

The Chancellor confirmed in the recent budget that these thresholds would be revised upwards. The lower, personal allowance will rise from £11,850 to £12,500 from next April. The threshold for higher rate tax will rise from £46,350 to £50,000.

So, for the 2019/20 tax year, if you want to avoid paying 40% tax, you need to be earning under £50,000 a year.

You probably don’t want to tell the boss that you need him to pay you less or change to a job that doesn’t pay as well, but there is another way to reduce your taxable salary.

The contributions you make into your pension are deducted from your salary before your tax is calculated. So, in effect, paying into your pension reduces your taxable salary.

So, if you earn £60,000 a year and pay 10%, or £6,000, into your pension, then your taxable salary will be £54,000. This is above the higher rate tax limit, and you will be paying 40% of £4000, or £1,600 to HMRC.

But if your salary is £60,000 and you contribute 17.5% – £10,500 – to your pension, then your taxable salary falls to £49,500. This is below the new higher tax threshold, and you pay 20% tax on all your earnings.

However, thanks to the way the pension system works, you will still enjoy 40% tax relief on the relevant contribution, meaning that your £10,500 puts a great deal more into your pension pot.

If the contribution is made through your employer’s scheme, this is will be done for you. If you’re saving through a personal pension, you’ll need to reclaim the extra 20% due to higher-rate payers through your tax return.

Of course, this will leave you with less spending money each month and might not be practical if money is tight. But if you have paid off your mortgage and the kids have left home, a little less cash now might not be a problem, particularly if it means a more generous pension in the future. All you need to do is wait until you turn 55, and you can start enjoying the money you stopped the taxman from taking.

What should you do?

As with anything to do with tax, things can become complicated very quickly. Careful financial planning and expert advice will be essential to avoid any nasty, and potentially costly surprises.

A call to the Continuum team could provide it.

The value of your pensions and investments, and the income from them, can fall as well as rise and you may get back less than you invested.

Tax treatment varies according to individual circumstances and is subject to change.