Are you a high earner? Did you know that by simply making use of your pension, there’s an investment which provides a 72% risk-free return, overnight?
Pensions are an excellent vehicle to grow your wealth, and in this article, we’ll explain how you can make the most of your contributions, with some expert financial planning.
Income tax rates
First of all, you’ll need understand the current income tax rates. This is the tax you pay on your income, hence its name.
The amount of income tax you pay each tax year depends on how much of your income:
- Is above your Personal Allowance; and
- Falls within each tax band
The income tax rates for the tax year 2021/2022 are:
- Personal Allowance — income up to £12,570 — tax rate 0%
- Basic rate — income of £12,751 to £50,270 — tax rate 20%
- Higher rate — £50,271 to £150,000 — tax rate 40%
- Additional rate — over £150,000 — tax rate 45%
Therefore, any income over the £50,270 threshold, as a higher-rate tax payer, is taxed at 40% in income tax, and an additional 2% National Insurance. For example, if you were to receive a £1,000 bonus from your employer, only £580 will arrive in your bank account after tax has been deducted.
The amount of National Insurance you pay depends on your employment status and how much you earn. In addition, from 6th April 2022 to 5th April 2023, National Insurance contributions will increase by 1.25%. The increase will apply to:
- Class 1 (paid by employees)
- Class 4 (paid by self-employed)
- Secondary Class 1, 1A and 1B (paid by employers)
The increase will not apply if you are over the State Pension age.
However, if you plan carefully, and use your pension, you could ultimately, pay less tax.
How to use your pension effectively
Most employers use a method called salary sacrifice to pay pension contributions. Through this method, all pension contributions are gross of all tax, including income tax and National Insurance.
By using your pension, you can claw back the 40% in income tax and the 2% in National Insurance.
If we take the same example as above, but instead, you decide to place the £580 in your pension. This then receives an immediate uplift of £420 in tax relief — almost doubling your money and a 72% risk-free return, just from using your pension.
Using the same method and applying it to the maximum £40,000 annual contribution you can make to your pension (if you’re not subject to the tapered annual allowance), then you could receive an impressive £16,800 in tax relief.
This is a simple, tax-efficient method, but to make sure you’re fully making use of your pension, it is always best to consult with a financial adviser.
The annual allowance and tapering
The pension annual allowance is the maximum gross amount of pensions savings you can make each year with the benefit of tax relief. It is therefore something to be aware of as a high-earner if you are considering tax-efficient methods and financial planning.
For the tax year 2021/2022, the annual allowance is £40,000, or your earnings in that tax year – whichever is lower. Going over the annual allowance can result in a tax charge at the end of the year.
As previously mentioned, the annual allowance also reduces if you earn over £240,000 a year. Tapering reduces the allowance by £1 for every £2 of income above £240,000, down to a minimum annual allowance of £4,000.
If you think you’ll be affected by the tapered annual allowance, then you should consult an financial adviser from a financial planning firm, to ensure you’re making the most of the variety of tax vehicles available to you.
Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.
