Finding ways to mitigate tax may be an important part of your financial plan, especially if you are a high earner.
If you move into a higher tax band due to an increase in your income, you could see a significant change to your tax bill. Certain tax benefits and allowances may also reduce, which could further erode your wealth.
This could be more likely in the future due to frozen Income Tax thresholds. Luckily, there are several ways that you may be able to protect your wealth.
Read on to learn why you might be more likely to move into a higher tax band and what you could potentially do about it.
An additional 2.1 million people could become higher-rate taxpayers by 2027
In the 2021 Spring Budget, then chancellor Rishi Sunak announced that Income Tax thresholds would be frozen until April 2026. Since then, the government has extended the freeze until April 2028.
However, in that time, average wages have increased. According to the Office for National Statistics (ONS), in September and November 2023, the annual growth in regular earnings – excluding bonuses – was 1.4% when adjusted for inflation.
If your income increases while the thresholds remain frozen, this could mean that tax becomes payable on more of your wealth. In some cases, you could be more likely to move into a higher tax band as a result.
Indeed, according to MoneyWeek, there could be an estimated 2.1 million people pulled into the higher-rate tax bracket and 350,000 people becoming additional-rate taxpayers by 2027.
As such, it may be more important than ever to consider how to protect your wealth if you move into a higher tax band.
Increasing your pension contributions could help you remain in a lower tax band
If you are still working and are at risk of moving into a higher tax band, you may want to consider increasing your pension contributions.
When your employer pays you, they take the money for your pension contribution from your earnings and then Income Tax is deducted from the remaining funds.
As such, if you increase your pension contributions, you may be able to reduce your taxable income and remain in a lower tax bracket. Even if this is not feasible, and you can’t easily prevent yourself from moving into a higher band, you could still reduce the Income Tax you pay by paying more into your pension.
Additionally, you benefit from tax relief on these contributions and your employer might match them, so the funds may be “worth” more in your pension.
Don’t forget to claim additional tax relief on your pension contributions
Moving into a higher tax band often means that you pay more tax, but you may also be able to claim tax relief on your pension contributions at an increased rate.
Typically, you automatically receive 20% tax relief on your contributions at source. If you are a higher- or additional-rate taxpayer, you are normally entitled to 40% or 45%. However, you must claim the extra 20% or 25% through self-assessment.
In July 2023, Standard Life reported that there was £1.3 billion in unclaimed tax relief in the UK.
So make sure you claim all the tax relief you are entitled to. This could help offset some of the additional tax you may pay elsewhere when you move into a higher tax band.
Be prepared for a reduction in your Personal Savings Allowance
Your “Personal Savings Allowance” (PSA) is the amount of interest you can generate on non-ISA savings before paying interest. Your PSA depends on your marginal rate of Income Tax.
In the 2023/24 tax year, your PSA is:
- £1,000 if you are a basic-rate taxpayer
- £500 if you are a higher-rate taxpayer
- £0 if you are an additional-rate taxpayer.
Any interest that exceeds your PSA is typically taxed at your marginal rate of Income Tax. So, if you move into a higher tax band, you may pay more tax on your cash savings interest.
Fortunately, there are ways to potentially mitigate this.
Firstly, you may want to use your full ISA allowance – £20,000 in 2023/24 – before saving elsewhere as you do not pay tax on any interest generated from savings held in an ISA.
Next, if your partner is in a lower tax bracket than you, it may be worth considering how you hold your savings between you. This may allow you to use both your ISA allowances and reduce the tax you pay.
They also have a higher PSA than you and their marginal rate of Income Tax is lower, so even if they do pay tax on their cash savings interest, they could pay less than you.
Finally, if you have a significant amount of wealth in cash savings and you are concerned about the tax you will pay on the interest, it may be worth considering some alternatives, such as investing or contributing to your pension.
Bear in mind that investments may attract some tax too. It may be wise to seek professional advice, so you understand what you are likely to pay.
Consider using tax wrappers to mitigate Dividend Tax
Any investments you hold in a Stocks and Shares ISA are free from tax. However, you may need to consider the tax you could pay on any non-ISA investments, particularly if you’re likely to move into a higher tax band.
If you hold stocks and shares, you may earn dividends – profits from the company distributed to shareholders.
Normally, you don’t pay tax on any dividend income that falls within your Personal Allowance of £12,750 in the 2023/24 tax year.
Additionally, individuals have a “Dividend Allowance” of £1,000 in 2023/24. However, any dividend income that exceeds this threshold is subject to tax. You could pay:
- 8.75% if you are a basic-rate taxpayer
- 33.75% if you are a higher-rate taxpayer
- 39.35% if you are an additional-rate taxpayer.
As a result, moving into a higher tax band could mean that your Dividend Tax bill rises. The Dividend Allowance is also set to fall to £500 on 6 April 2024, so you may be more likely to pay Dividend Tax in the future.
One effective way to potentially mitigate this tax is to move investments using a process known as “bed and ISA”.
This involves selling non-ISA investments and then purchasing them again in a Stocks and Shares ISA. Provided you have enough of your ISA allowance left to do this, you may be able to reduce the Dividend Tax you pay in the future.
Bear in mind you may pay Capital Gains Tax (CGT) when selling investments, and higher- and additional-rate taxpayers typically pay more than basic-rate taxpayers. As such, you may want to seek professional advice before doing this to ensure you are being as tax-efficient as possible.
If you are likely to exceed your Dividend Allowance and have already used your ISA allowance. you might also consider increasing your pension contributions. The funds are invested on your behalf, so you may still see growth over time, and you won’t pay tax on any gains from investments in your pension.
Using tax wrappers in this way could be an effective way to reduce a large Dividend Tax bill.
Get in touch
If you are likely to move into a higher tax band or would like to know more about how you could benefit from tax-efficient saving and investments, we can help.
Please give us a call on 01276 855717 or email email@example.com today.
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Tax concessions are not guaranteed and may change in the future. Tax free means the investor pays no tax.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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