From 6th April 2011 approx. 750,000 people are going to find themselves thrown into the higher rate tax band. Find out whether you're one of them & what you can do about it.
The amount you can earn before you start paying 40% tax fell on the 6th April, 2011. From that date anyone that earned over £42,476 found themselves in the higher rate tax band.
This is because personal allowance (the amount you can earn before tax) is increasing by £1,000 to £7,475 for anyone under the age of 65. However, to stop higher income households benefiting, the taxable income threshold for higher rate tax is being lowered at the same time.
Consequently, more people are going to find themselves paying more tax, even if they don't actually earn anymore.
There are a number of ways you can lower your taxable earnings so that you either keep your taxable income under the new £35,001 limit (this is the equivalent to a gross salary of £42,476) but you need to move quickly.
Here are your options:
What can you do about it?
1. Check your tax code
The first thing you need to do is make sure you're paying the right amount of tax now. The most straight forward way to do this is to check that your tax code is correct. You can find your tax code on your latest pay slip or P60 and find out how to make sure HMRC have it right by reading our article: Are You Paying Too Much Tax?
Once you've confirmed that you are going to be hit with higher rate tax on earnings over £42,476 you need to look at how to lessen your taxable income so you stay within the 20% tax band.
2. Use your ISA allowance
Any savings or investments you hold in an ISA are protected from income tax, capital gains tax and tax on dividends. As such you should ensure that you use your full £11,280 allowance to your advantage as any interest you earn on taxable savings and investments will add to your total income.
If you hold savings and investments that aren't in ISAs and haven't yet used your ISA allowance, you should look at transferring your money to make it tax-proof as soon as possible.
You will need to double check that you won't be penalised for moving your money, shop around for the best Cash ISA and Investment ISA for your circumstances, apply and transfer your money before 5th April to make the most of this year's tax free savings allowance.
3. Top up your pension
Pensions are another tax-efficient way to save for the future and to lessen your taxable income. If you pay into a pension scheme set up with your employer it's likely that any contributions will be deducted from your salary before tax. This means that by increasing your pension contributions you can lessen the amount of money liable for tax at the 40% rate.
You will need to consider whether adding more to your pension is the right choice as your money will be tied up until retirement. However, it is an option seriously worth considering, especially if your employer offers to match your contributions.
3. Consider childcare vouchers
If you have children then it's worth investigating whether childcare vouchers present a viable way for you to lessen your taxable salary.
Each parent can buy up to £55 worth of childcare vouchers a week via salary sacrifice, the vouchers can then be used to pay for childcare of your choice. As you buy the vouchers out of your pre-tax salary you lessen your taxable income and benefit from significantly more childcare for your money.
Again, you need to act fast if your soon going to be drawn into the 40% tax bracket.
This is because higher rate tax payers that sign up to the scheme after 6th April will only be able to get basic rate tax relief (20%) on childcare vouchers, as opposed to the 40% they get now. However, sign up before 6th April and you'll still be able to benefit from 40% tax relief thereafter.
You can buy childcare vouchers in advance of when you need to use them so it is worth looking at registering now, even if you don't need childcare yet.
The issue is slightly complicated by the fact that childcare vouchers can affect your liability for child tax credits so it's not a decision that you should take lightly. Read our step-by-step article I Want to Cut the Cost of Childcare to find out more about your options.
4. Get a new bike
If cycling to work is a realistic option for you then CycleScheme is worth investigating.
It's a means of buying a new bike through salary sacrifice payments. Providing you get your employer on board you'll be able to pay for a bike of your choice in instalments deducted from your pre-tax income. You get a new bike, the opportunity to get fit without paying for the gym, and lessen your taxable salary.
Read our article How Cyclescheme Can Save You Money to find out more.
5. Ask for health care
Health care is another benefit-in-kind that you can pay for out of your pre-tax salary. If your employer doesn't already offer private medical insurance it's worth asking whether this is something they will consider. Sign up to a scheme and while the amount you take home will lessen slightly, you may be able to save this amount back if your taxable income is reduced to under £35,001.
6. Investigate other perks
If you're on the cusp of the new 40% tax band it's worth asking your employer whether they're able to offer any other benefits via salary sacrifice or through some other means that would lessen your taxable income.
Ridiculous as it sounds, it's seriously worth looking at whether asking for a slight pay cut in return for a tax-efficient benefit would see you better of financially.
7. Transfer your assets
If you're going to find yourself in the higher rate tax band, but your spouse only needs to pay basic rate tax at the 20% rate (or no tax at all), then you should consider transferring joint assets - like savings and investments - into their name. This would ensure that you get as much benefit as possible from your savings and investments, and mean that any interest earned would push you into the 40% bracket.
Read our article Does Being Married Make a Difference to Your Finances? for more information on the implications.
