Planning for Retirement

Pensions and your personal allowance

  • Shunil Roy-Chaudhuri
  • 09 December 2021
  • 4 mins

Earners can be hit by a 60% tax on income of more than £100,000, but this could be reduced by putting more into a pension.

The 60% tax that can be imposed on an income of between £100,000 and £125,140 in England, Wales and Northern Ireland has been called the highest tax band in Europe by the Financial Times. However, earners could bring the rate down by saving more for retirement.

How much can I save tax-free for retirement?

Well, there are limits, with the tax relief on pensions restricted to the higher of the following two amounts:

  • £3,600; or

  • 100% of what HMRC describes as ‘relevant UK earnings’, up to the maximum annual pension allowance of £40,000 (for more information on this, see our article on Tapered pension allowance for high earners). Some income, though, doesn’t count as ‘relevant UK earnings’ in the eyes of HMRC, including dividends and investment income, and income from pensions. So income from these sources cannot be included when you’re calculating how much you can put tax-free into a pension.

Is there really a 60% tax rate?

Yes and no. There is no official 60% UK tax band, but salary earners can end up paying this rate because HMRC claws back the annual personal allowance for salaries above £100,000.

What is the personal allowance?

This is the part of our salary that is not liable for tax, and is currently £12,570. In other words, we pay no tax on the first £12,570 of our annual income.

Except when we earn more than £100,000?

Exactly. For every £2 of salary above £100,000, the personal allowance is reduced by £1. This applies to salaries up to £125,140, at which point the personal allowance is entirely depleted.

How does this equate to a 60% tax rate?

Well, the depleted personal allowance is now taxed at 40%. So someone earning £120,000 will have lost £10,000 of their personal allowance, leading their tax bill to rise by £4,000. That person will have paid the usual 40% higher rate tax on their earnings between £100,000 and £120,000, amounting to £8,000. Add this to the £4,000 due to the loss of personal allowance and they will have paid £12,000 on the £20,000 of earnings between £100,000 and £120,000. That is an effective tax rate of 60%.

What happens after you have used up your entire £12,570 personal allowance?

Your personal allowance is fully depleted at the point when your income reaches £125,140. Above this amount there is no more personal allowance to deplete, so you are simply taxed at the higher rate of 40%. Annual income greater than £150,000 is taxed at the additional rate: 45%.

So your effective tax rate jumps to 60% for incomes between £100,000 and £125,140 and then falls back again?

Exactly.

That’s an anomaly…

Yes, it is.

Is there a way to avoid the 60% rate?

Absolutely. You can put up to £40,000 of your earnings above £100,000 into a pension, subject to the exclusions referenced earlier. You are not taxed on money you put into a pension, so you will avoid the 60% tax.

How does that work?

It’s simple. If you are earning £120,000 and you put all of your earnings above £100,000 into your pension, then your earnings above £100,000 will no longer be taxed. This means you will no longer have to pay the 60% tax you would otherwise have done. Instead, it goes straight into your pension along with the rest of your earnings above £100,000.

So, in this case, putting your income into your pension could leave you significantly better off overall?

Quite so. But there’s more. If your employer operates a salary sacrifice scheme, then you could make even greater savings (assuming you won’t breach your maximum £40,000 annual pension allowance).

How does salary sacrifice operate?

It’s very straightforward. Your employer has to pay National Insurance based on your salary. If your employer reduces your salary by exactly the same amount that you want to put into your pension, and then pays your pension contributions for you, then they will now have to pay less in National Insurance. If your employer adds this National Insurance saving to your pension, then you are even better off financially. In this case, you could gain almost 67%.

So should everyone put their income between £100,000 and £125,140 into a pension?

Not necessarily. To start with, you are only allowed to put up to £40,000 a year into a pension. Moreover, at present you cannot put more than £1,073,100 into a pension over the course of your lifetime. So there are limits to your pension investment.

What if I won’t exceed these limits?

You need to consider your broad life goals and financial objectives and create a financial plan to help you aim to achieve them. If investing this income into a pension could help you achieve your aims, then it may be worth pursuing. Even so, we would recommend you review annually any pensions you have and consider how they link in with your long-term objectives. In addition, while pensions may be the first avenue to consider regarding the 60% tax rate, they are not the only option.

What are the other considerations?

When giving holistic advice to a high earner we would also consider all other tax efficient vehicles, as some may well be appropriate. You may find speaking to a financial adviser helpful here, as they can look at the bigger picture. At Schroders Personal Wealth, we can provide such financial advice. Call 0808 296 6659 to book a free initial consultation today. There are no hidden fees or charges, and you’ll only pay if you choose to go ahead with the recommendations in your personalised financial plan.

Pensions are a long-term investment. The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits, which isn’t guaranteed, and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.

The value of investments and the income from them can fall as well as rise and the investor may not get back the initial investment.

Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

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In preparing this article we may have used third party sources which we believe to be true and accurate as at the date of writing. However, we can give no assurances or warranty regarding the accuracy, currency or applicability of any of the content in relation to specific situations and particular circumstances.

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