Many people understand that earning over 100k is the point where you begin to lose your personal allowance and edge closer to the 45% tax rate.
For every £2 of earnings over £100,000, the personal allowance is reduced by £1. Therefore, individuals earning over £125,141 will have no personal allowance and the effective rate of income tax between £100,000 and £125,141 is 60%.
An individual who earns £100,000 exactly will pay £27,432 of income tax, giving them a net take home of £72,568.
Compare this with an individual who earns £135,000, what happens? The income tax to pay increases to £46,953, reducing that individual’s net take home to £88,047 per annum.
That’s an extra £35,000 of income, with a net take home difference of only £15,479.
WHAT ELSE SHOULD YOU KNOW?
In addition to the tax burden, the following income-related benefits are also lost, including the entitlement to government-funded tax-free childcare of up to £2,000 a year.
To pay for this additional childcare from net salary, £3,636 of gross income is required. This effectively adds £1,636 of tax to the overall tax bill.
The total cost of earning an additional £35,000 over £100,000 for working parents entitled to tax-free childcare is therefore:
- Additional tax due to loss of personal allowance and 45% rate of £19,028. This is an effective rate of 54.3% on the income above £100k
- Loss of tax-free childcare, £2,000 value per year
The total additional cost of sacrificing the gross income to pay the childcare and tax due on the income is £48,460, reducing the net take home to £86,540. That means the effective net difference between this person and a £100k earner is £13,972, despite an additional £35,000 of income.
On top of the tax burden, the 30 hours of free childcare per week is reduced to 15 hours per week.
To put this in perspective, let’s look at an example of a family with two children, say 1 and 3 years old.
If the higher earning parent receives a pay rise of £5,000 taking their income from £100,000 to £105,000, they will pay an additional £3,000 of income tax. They would also lose £4,000 of government funded childcare a year and lose 15 hours of free childcare a week, which could be worth approximately £3,000 in a year.
In short, a pay rise of £5,000 has cost the family over £10,000. And, considering the upcoming expansion to the free childcare provisions to cover younger children, the costs could be even higher.
WHAT CAN YOU DO?
- Consider pension contributions
- Consider when bonuses are paid and the tax impact of participating in employer share schemes
- Consider salary sacrifice for tax-efficient benefits in lieu of salary (there are many options here, including tax-efficient company cars)
- Don’t forget to include charitable donations on your tax return
- Consider tax-efficient investments
- Consider tax structuring for investments that provide income outside of your employment, small scale consideration may relate to utilising ISAs. Larger considerations may relate to considering the use of a family investment company or a family trust.
So, if you’re earning over £100k, there’s plenty to ponder, and if you’d like any advice on getting your finances in order, get in touch.
