Can more tax ever be a good thing? Planning for the additional rate band reduction.
This article was published in January 2023
As Independent Financial Advisers, we clearly think one’s personal finances are important. However, financial wealth is not an end in itself. It is simply an important factor in achieving a meaningful life without regrets. What a ‘meaningful’ life looks like is different to everyone. While some find meaning through work, others may find it through connection with friends, family, or to their wider community. In truth, for most, a life without regrets will entail finding the right balance between many facets of their lives.
When looking at tax changes, specifically tax increases, it is best not to be disheartened right away. With the right insight and planning, even seemingly strict increases can present new opportunities through changing financial incentives. If these changes are understood, they could prompt decisions which allow some to get closer to the ideal balance necessary for a life well-lived.
Changes to the additional rate band
From 6 April 2023, the additional rate tax band is being reduced from £150,000 to £125,140. This will cost those who are already in the additional rate band an extra £1,243 per year.
Employees who earn £150,000 and above will pay an effective 54.5% of their earnings in income tax and national insurance (NI) of £27,271 on the part of their income that falls into the band from £100,000 to £150,000, This is calculated as follows:
| Tax and NI | |
|---|---|
| 60% income tax (because the personal allowance tapers away by £1 for every £2 of income) on income between £100,000 and £125,140 | £15,084 |
| 45% income tax on income between £125,140 and £150,000 | £11,187 |
| 2% NI between £100,000 and £150,000 | £1,000 |
| Total | £27,271 |
£27,271/£50,000 = 54.54%. This compares to £26,028, or 52.05% for the current tax year.
On the surface, the lowering of the top tax band may simply be taken to mean those on high incomes pay more in tax. However, due to how different tax rates, bands and the personal allowances interact, it should be noted that the structure of financial incentives around certain decisions have shifted somewhat.
Cutting down working hours
Higher earners who are feeling the stresses of work, or who would love to spend more time on their interests or with their family, should note how the personal allowance becoming closer to the additional rate band could affect them.
If a reduction of working hours leads to a salary falling between £100,000 and £125,140, the trade-off between time spent working and time spent doing anything else will be different in tax year 2023/24. Those with a good financial plan are able to fully consider this trade-off, and understand if it is feasible without jeopardising any longer term goals.
Take the following example: An individual earning £140,000 reduces from a five to a four-day working week (for a commensurate 20% cut in salary).
This individual’s post-tax salary will reduce by £12,869 (£28,000 salary reduction minus a tax and NI saving of £15,131). That equates to a 15% cut in salary, in exchange for a 20% cut in working hours. This seems like quite a good deal.
| Before | After | |
|---|---|---|
| Salary | £140,000 | £112,000 |
| Personal allowance (reduced by £1 for every £2 of income) on income between £100,000 and £125,140) | £0 | £6,570 |
| Taxable income | £140,000 | £105,430 |
| Tax at 20% on £37,700 | £7,540 | £7,540 |
| Tax at 40% on £87,440 / £67,730 | £34,976 | £27,092 |
| Tax at 45% on £14,860 | £6,687 | |
| £49,203 | £34,632 | |
| 12% NI between £12,570 and £50,270 | £4,524 | £4,524 |
| 2% NI between £50,270 and £140,000/£112,000 | £1,794.60 | £1,234.60 |
| £6,318.60 | £5,758.60 | |
| Total tax and NI | £55,521.60 | £40,390.60 |
| Net income | £84,478.40 | £71,609.40 |
Increasing pension contributions
Pension contributions are an extremely important way of ensuring that a desired lifestyle can be achieved after retirement. We believe retirement should be seen as a time of flourishing and new opportunities. For this to be the case, people must have significant savings for when their income stops. A larger pension pot could allow an early retirement, or greater financial freedom to enjoy a retirement with.
The reduction of the additional rate band could be seen as an opportunity for increasing one’s pension pot. Instead of reducing their working hours by 20%, an employee earning £140,000 could use salary sacrifice to swap 20% of their salary for an employer pension contribution. In this case, the employee would be in the same net income position as above, but would also have £28,000 more in their pension (even more if their employer adds it’s national insurance saving).
It is worth noting here that the maximum pension contribution per year is £60,000. If this number has not been met in the past 3 years it is possible to carry forward relief. For individuals who earn more than £200,000, their maximum pension contribution of £60,000 may be reduced.
| Before | After | |
|---|---|---|
| Salary | £140,000 | £112,000 |
| Personal allowance (reduced by £1 for every £2 of income) on income between £100,000 and £125,140) | £0 | £6,570 |
| Taxable income | £140,000 | £105,430 |
| Tax at 20% on £37,700 | £7,540 | £7,540 |
| Tax at 40% on £87,440 / £67,730 | £34,976 | £27,092 |
| Tax at 45% on £14,860 | £6,687 | |
| £49,203 | £34,632 | |
| 12% NI between £12,570 and £50,270 | £4,524 | £4,524 |
| 2% NI between £50,270 and £140,000/£112,000 | £1,794.60 | £1,234.60 |
| £6,318.60 | £5,758.60 | |
| Total tax and NI | £55,521.60 | £40,390.60 |
| Net income | £84,478.40 | £71,609.40 |
| Plus pension fund | £28,000 |
The best decision for you depends greatly on both your financial position and your needs and goals for the present and the future. It is recommended you speak to an adviser before making any decisions concerning these upcoming tax changes.
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