Pension contributions and high income earners

Our previous government enacted legislation that removed the personal allowance for certain high income earners. The present government has made no change to this process. Basically, for every £2 your income exceeds £100,000, your personal allowance is reduced by £1.

Take, for example, the case of Joe Smith who has income for 2014-15 of £100,000 and a personal tax allowance of £10,000 – this leaves income subject to tax of £90,000 and a tax bill of £29,627.

Joe’s best friend, Charlie, has income of £120,000. Based on the £1 reduction for every £2 of income over £100,000, Charlie has lost entitlement to his personal allowance of £10,000 and his tax bill amounts to £41,627.

Charlie’s extra tax, compared to Joe’s, is £12,000. His income is £20,000 higher than Joe’s and accordingly, his marginal rate of tax on this amount is 60% (£12,000/£20,000).   

This 60% Income Tax rate can be avoided. For instance, Charlie could pay a net contribution into his pension of £16,000 (gross premium £20,000) and this will reduce his taxable earnings to £100,000 saving him £8,000 in Income Tax – Charlie also receives 20% tax relief at source of £4,000 – the combined tax saved is therefore £12,000.

There are other strategies that can be employed to similar effect. If your income is likely to exceed £100,000 for the first time this tax year please call so we can discuss your options in more detail.