For high income earners, considering ways to reduce tax is an important part of wealth management. With the highest rate of Income Tax in the UK currently at 45%, it’s crucial to have a tax strategy in place.
The good news is that with a little planning, high earners can reduce tax liabilities significantly. With that in mind, here’s a look at five tax minimisation strategies for those on high incomes to consider.
Making pension contributions to reduce tax liabilities
One of the most straightforward ways to reduce tax liabilities as a high income earner in the UK is to contribute to a pension. Within a pension, all growth is free of capital gains and income tax. More importantly though, contributions come with tax relief. This means that they can significantly lower your Income Tax bill.
For the 2023/2024 tax year, the standard annual pension contribution allowance for tax relief purposes is 100% of your salary or £60,000, whichever is lower. However, if you have an ‘adjusted income’ of more than £260,000 per year and a ‘threshold income’ of more than £200,000 per year, your annual allowance will be tapered.
One way to potentially get around a tapered allowance is to make use of any annual pension allowance that you have not used in the three previous tax years, under ‘pension carry forward’ rules. You may also be able to make contributions on behalf of your spouse, who will have their own annual pension allowance.
It’s worth noting that pension contributions can be a particularly effective way to reduce tax for high income earning business owners and company directors. For limited companies, pension contributions are an allowable business expense. This means that they can reduce your company’s taxable profits and, in turn, its Corporation Tax liability. Additionally, contributions are not subject to National Insurance (NI). Meanwhile, by paying into your pension instead of paying yourself a dividend, you can reduce the amount of dividend tax you pay.
Pension contributions can also be an effective way to minimise Inheritance Tax (IHT) liabilities. Your pension is not part of your taxable estate, meaning that it is not subject to IHT.
Salary exchange for PAYE employees
Another way high income earners can reduce tax is using salary exchange or salary sacrifice. Many employers offer this option to PAYE employees to support various positive initiatives, such as pension contributions, electric vehicle (EV) ownership, or gym membership.
With a salary exchange arrangement, the cost of the chosen benefit is deducted from full pay before tax and National Insurance are calculated. The difference is then used to fund additional pension savings, or the purchase of the EV or gym membership etc.
As you’re earning a lower salary, both you and your employer will pay lower National Insurance contributions (NICs), which often means your overall take-home pay will be higher.
Furthermore, in the case of pension contributions, this means that you no longer need to wait for additional rate tax relief to be given on your pension contribution.
Most employers will recognise your pre-sacrifice salary as a ‘notional’ salary for life assurance and mortgage application purposes, but it’s worth checking that this is the case.
Contributing to an ISA to reduce tax as a high income earner
Moving away from pensions, another straightforward way for high income earners to reduce tax is contributing to a Stocks & Shares ISA (Individual Savings Account). Within a Stocks & Shares ISA, all capital gains, dividend income, and interest are tax-free.
Currently, every adult in the UK has an annual ISA allowance of £20,000. This means that a couple could potentially save £40,000 per year into ISAs, sheltering a significant amount of money from HMRC.
It’s worth pointing out that children currently have an annual allowance of £9,000. So, if you have maximised your own ISA allowance, you could consider contributing to your child’s ISA. Bear in mind, however, that if you do contribute to your child’s ISA, the money will belong to them, and they can withdraw it when they turn 18.
Considering Venture Capital schemes
For those that have maxed out their pension and ISA allowances, the next port of call for high income earners to reduce tax is to consider investment into a Venture Capital Trust (VCT) or Enterprise Investment Scheme (EIS).
VCTs are quoted companies on the stock exchange and investment into them qualifies for a 30% Income Tax break at point of investment. They also provide investors with tax-free dividends over the duration of the investment with a minimum qualifying period of five years. The quoted nature allows these investments to be traded at any time, although if done so before the qualifying period expires all tax relief will be lost. On realisation of the investment, no Capital Gains Tax (CGT) is payable, and the proceeds can be recycled into a new investment to receive a full set of tax concessions.
The EIS is even more speculative as it involves investment in unquoted early-stage companies. Again, investors qualify for a 30% Income Tax break at the point of investment, however, investments need to be held for a minimum of three years to qualify for the tax relief. EIS also allows investors to hold over Capital Tax for gains accrued one year prior to the investment and three years thereafter. There is no CGT liability on gains on disposal of this type of investment.
It’s worth noting that both types of investment are higher risk and the attractive tax concessions should not outweigh the very careful selection of the underlying investment. It is therefore prudent to seek professional investment advice from a specialist adviser.
Charitable giving for high income earners
High income earners looking to reduce tax may also want to consider charitable giving. When charitable donations are made through Gift Aid, charities can reclaim the basic rate of tax you’ve already paid on your donation. This means that a £100 donation is effectively worth £125 to the charity. In addition, if you are a higher-rate taxpayer, you can claim back the difference between the higher rate and basic rate tax on the value of your donation. This means that a 40% taxpayer can claim back £25 for every £100 they donate.
The answer – seek expert advice
Of course, when it comes to reducing tax liabilities, nothing beats speaking to an expert. An expert will be able to assess your situation and help you develop a comprehensive plan designed to minimise the amount of tax you pay, taking into account Income Tax, Capital Gains Tax, and Inheritance Tax.
At Bowmore Financial Planning, we have years of experience helping high income earners develop strategies to mitigate their tax positions. We can help you understand tax changes, uncover tax savings, capitalise on pension allowances, take steps to protect your assets from IHT, and more.
To find out more about how we can help you reduce your tax liabilities as a high income earner, contact us here or call us on 01275 462 469.
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority
- The Financial Conduct Authority does not regulate Estate Planning or Inheritance Tax Planning.
- Bowmore Financial Planning Ltd is not regulated to provide tax advice
- The value of your investments can go down as well as up, so you could get back less than you invested
- The tax treatment of certain products depends on the individual circumstances of each client and may be subject to change in future
- A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.
