As the UK’s cost of living crisis has continued into 2023, it is becoming harder for many households to manage their finances. Last year, around 8m people were in “financial trouble” or in “financial difficulty”. Fast forward six months, the figure has soared to nearly 11m.
Did you know that one-fifth of UK workers are expected to pay the 40% higher rate of income tax on their earnings by 2027? Could you be on course to inadvertently pay higher tax?
With the cost of living crisis now leading UK households to face a 5.7% fall in real incomes in 2023 (the biggest “pinch” since 1957), tax planning is arguably even more important than ever.
In this article, our Carlisle financial planners explain why many workers are facing a higher tax liability and offer ideas on how to mitigate this.
Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137
e: [email protected]
Why are more workers set to pay the higher rate?
Over a million more people are expected to be pulled into the 40% higher rate in the coming years due to two main reasons – frozen tax bands and average wage growth.
In the 2022 Autumn Statement, the Chancellor confirmed that UK income tax bands would be frozen until 2027-28. For instance, the tax-free personal allowance will remain at £12,570 for each tax resident for the coming years.
Whilst some welcomed the news that there would be no increase in income tax rates, others have criticised this tax freeze as a “stealth tax”. This is because more workers will be dragged into higher rates of tax as their pay gradually goes up.
For instance, suppose you earn £50,000 in 2023-24. If you get a pay rise in line with average UK wage growth (7.2% between February and April 2023), then in 2024-25 you could start paying the 40% higher rate as your wage crosses over the £50,271 threshold.
For those earning near – or over – £100,000, the April 2023 tax year brings even more challenges after the threshold was lowered for the 45% additional rate of income tax. Last year, this stood at £150,000. Now, any income above £125,140 will be taxed at 45%.
As such, a taxpayer earning £130,000 in 2022 would suddenly become an additional rate taxpayer in 2023-24 (assuming the same earnings and no preparatory action was taken).
How can I protect my finances?
Unfortunately, it may not be possible (or wise) to take a lower-paying job to avoid paying a higher rate of tax. Remember, living costs go up each year due to inflation. Even to retain spending power, your earnings will likely need to keep rising.
However, there are still some useful financial planning tools at your disposal to help reduce a needless tax liability in 2023-24.
Firstly, explore ideas to make full use of your tax-free personal allowance. If you are living with your partner, for instance, remember that each of you can earn £12,570 annually without an income tax charge. With some careful planning, certain households can use this to their benefit.
For example, suppose a couple have recently had a child. Should one person go back to work full-time whilst the other stays at home (thus using only one personal allowance)? Or, should both return to work, thus generating two incomes and benefitting from two allowances?
If the couple decides that it is best to pursue the first option, then can you use the Marriage Allowance? This allows the lower earner (or non-working person) to transfer up to £1,260 of their tax-free allowance to their spouse or civil partner.
A second idea is for higher earners to explore charitable giving as a tax planning strategy. In particular, if you make a Gift Aid declaration, then your basic and higher rate tax bands are extended by the gross charitable donation.
For instance, a higher rate taxpayer gives £100 to charity in 2023-24. This extends his basic rate band by £125, from the normal £50,270 to £50,395.
This means that £125 of income that would have been taxed at 40% is now taxable at 20%.
For an additional rate taxpayer, the tax benefits of Gift Aid can be even greater. This is because certain taxpayers could gain some/all of their tax-free personal allowance back.
For every £2 earned above £100,000 in 2023-24, your £12,570 tax-free allowance is reduced by £1 – to the point where it disappears at £125,140. In effect, this leads to a 60% tax rate on income between £100,000 and £125,140.
However, by making Gift Aid declarations, you could increase your higher rate band beyond £100,000 whilst also reclaiming your personal allowance.
A third option to consider is salary sacrifice. Here, you speak with your employer about replacing some of your cash salary with non-taxable – or tax relieved – income.
For example, with the Cycle To Work scheme, you can choose a bicycle and gear, getting your employer to pay for it. You then gradually repay the money using salary sacrifice, letting you save on tax and national insurance.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.