4 simple ways to remain tax-efficient when you move into a higher Income Tax bracket

Read on to discover four simple ways to remain tax-efficient when you move into a higher Income Tax bracket or receive a pay rise.

A popular method for reducing Income Tax is to make additional contributions to your workplace or personal pension scheme. This is because pension contributions currently qualify for tax relief at your marginal rate.

If you are a basic-rate taxpayer, you automatically receive 20% tax relief on contributions. So, contributing £100 to your pension only costs you £80.

Pension contributions usually receive basic-rate income tax relief, but if you’re a higher- or additional-rate taxpayer, you have to claim the extra 20% or 25% relief by filing a self-assessment tax return or by contacting HMRC directly.

If your salary or earnings increase, making additional pension contributions enables you to keep your take-home pay at the same level as before the raise, while ensuring the extra income is fully tax-efficient by being redirected into your pension fund. By doing this, you effectively lower the percentage of your income that you pay in tax.

Moreover, if you are a business owner, contributing to a pension through a limited company can bring significant tax advantages. This is because pension contributions can be treated as an allowable business expense and can even be offset against your business’s Corporation Tax bill.

This method is particularly beneficial if you start earning over £100,000.

Once you pass this pay threshold, your Personal Allowance tapers by £1 for every £2 earned above it. So, in this instance, without contributing some of your excess salary to your pension, you risk falling into a tax trap in which you pay an effective rate of 60% on your earnings between £100,000 and £125,140.

By making additional pension contributions, you can help preserve your Personal Allowance – reducing your Income tax liability – while ensuring that your increased earnings are tax-efficiently invested. So, this strategy not only lowers your current tax bill but also boosts your long-term retirement savings.

Before making additional pension contributions, it’s a good idea to speak with an Amber River financial planner. They can work with you to ensure your additional salary or earnings remain tax-efficient and align with your wider goals.

And remember that a pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available to you.

If you’re a business owner and run a limited company, it may be more tax-efficient to pay your income in dividends.

You benefit from the dividend allowance of £500, and you pay tax on dividend income above that threshold based on your Income Tax band:

As you can see, Dividend Tax is considerably lower than Income Tax. There are also no National Insurance contributions (NICs) payable on dividends.

However, there are a couple of disadvantages to this approach.

For example, you can only pay out dividends from profits after you have paid Corporation Tax – unlike a salary, which is a tax-deductible expense. Moreover, dividends don’t count as “relevant UK earnings” for tax relief purposes on any pension contributions you make.

It may be beneficial to consult with an Amber River financial planner before deciding to take your income as dividends to ensure it’s the most effective strategy for your financial situation.

Salary sacrifice is a workplace arrangement where you exchange part of your monthly salary for non-cash benefits.

By reducing your salary, you pay less Income Tax and National Insurance. Employers also benefit from salary sacrifice schemes, as they save on their NICs.

Salary sacrifice schemes can comprise any number of options, but popular ones include:

If you’ve recently received a pay rise and are concerned about paying more tax on your income, consider exploring salary sacrifice options. You could come to an arrangement that not only reduces your tax burden but also offers savings to your employer.

If you’re in a relationship, coordinating your finances can help maximise allowances and reduce your tax liability.

For instance, if your partner has unused Personal Savings Allowance (PSA), you could hold savings in their name. Similarly, if one of you is in a lower tax bracket, it may be more efficient for them to hold the majority of non-ISA savings to benefit from a lower tax rate on the interest earned.

You can also share your Capital Gains Tax Annual Exempt Amount with your spouse or civil partner, and if one of you earns below the Personal Allowance, they can transfer some of it to the other partner using the Marriage Allowance.

There are various strategies to enhance tax efficiency as a couple, and a financial planner can help identify the best options tailored to both of your financial needs.