16 Jun 2023
By Scott McIver, Tax Manager, Armstrong Watson
While Scottish income tax rates and bands mean lower earners pay less tax than those in other parts of the UK, high earners could be paying up to 63% in income tax.
This isn’t an official rate of income tax and isn’t mentioned in any legislation, but comes from the tapering of the personal allowance when your income goes over £100,000.
The good news is there are ways to reduce your taxable income - one of which is to make pension contributions - to effectively sidestep this tax pitfall.
Impact of the new tax rate change
As a result of recent tax changes, since 6 April 2023 the effective rate of income tax for those earning between £100,000 and £125,140 has increased from 61.5% to 63%. This is due to the reduction to the top rate tax band threshold from £150,000 to £125,140 (the point at which you lose your personal allowance) and the increase in the higher rate from 41% to 42%.
If you earn more than £100,000, your personal allowance of £12,570 is reduced in increments until it reduces to NIL at £125,140. Once it reaches NIL, not only have you lost your tax-free allowance, but you will have reached the Top Rate tax threshold and be straight into the realms of 47% income tax.
For anyone with income between £100,000 and £125,140, it is this reduction in personal allowance (which saves tax at 21%), combined with the higher rate of 42% tax, which applies to this income, that creates the 63% tax rate.
For example, a higher-rate taxpayer earning £100,000 receives a bonus of £10,000. This £10,000 bonus is taxable at higher rates of tax (42%) resulting in a tax liability of £4,200. Then, as the income has breached £100,000, the personal allowance begins to reduce by £1 for every £2 over. The £10,000 bonus now reduces the tax-free personal allowance by £5,000 effectively subjecting previously untaxed income to higher rates of tax (42%) resulting in a further tax liability of £2,100.
That means that the original £4,200 tax paid, plus the additional £2,100 due because of the personal allowance reduction, gives a total of £6,300 of income tax paid on the £10,000 bonus; an effective rate of 63%.
Reducing your taxable income
There are ways you can look to reduce your taxable income, which can be particularly attractive if you are just over one of the thresholds, one of which is by increasing your pension contribution.
Depending on your earnings, this could mean you avoid the 63% pitfall, while also enhancing your retirement benefits.
Our financial planning team can discuss if increasing your pension contribution is suitable for you, while our tax team can offer strategic tax planning solutions to meet your personal needs. For advice and support, please contact 0808 144 5575 or email help@armstrongwatson.co.uk
