The Secret to 60% Tax Relief for High Earners

As the tax year draws to a close, a select group of high-earning individuals possess the knowledge, foresight and discipline to make strategic sacrifices now, thus paving the way for significant enhancements to their future wealth. Moreover, they can do this without needing to invest in anything unusual or exotic.

For the sake of this article, I am referring to UK resident high earners on a gross annual salary (including bonuses/benefits) of at least ￡100,000 but not too much over ￡250,000. Do you fit into this range or know someone who could benefit from reading this article?

The Problem: How and When You Get Hit by 60% Tax

There is a hidden tax that I want to share with you. But first we should quickly run through the basics. Most people know the income tax rates:

• You get the first ￡12,570 tax free, known as the Personal Allowance.
• Then from ￡12,570 to ￡50,270 you pay 20% (Basic Rate).
• From ￡50,270 to ￡125,140 you pay 40% (Higher Rate).
• Anything above ￡125,140 you pay 45% (Additional Rate or Top Rate).
• Plus National Insurance (whatever that is).

Here is where it gets sneaky and a little complicated...

When you start earning over ￡100,000, you gradually begin to lose your ￡12,570 tax-free Personal Allowance. For every ￡2 you earn over ￡100,000, your Personal Allowance reduces by ￡1. So when your earnings hit ￡125,140 (￡12,570 x ￡2 above ￡100k), your Personal Allowance is gone. Many people have heard of this but very few will appreciate its impact.

Look at the first two bullet points above. You might think that as a result of losing your ￡12,570 tax-free Personal Allowance you would have to pay 20% Basic Rate tax on the whole of the first ￡50,270. That's what I used think, but what actually happens is worse: Instead, the point at which you start paying the 40% Higher Rate is lowered from ￡50,270 down to ￡37,700! Your 40% tax bracket gets extended backwards.

Since the Personal Allowance is reduced by ￡1 for every ￡2 you earn over ￡100,000, this effectively adds an additional 20% in tax for every ￡1 earned between ￡100,000 and ￡125,140. Adding to the 40% that you are already paying on earnings between ￡100,000 and ￡125,140, the effective tax rate for earnings in this range is a whopping 60%.

Oh wait, there is also National Insurance, which adds an extra 2% at this level. So 62% is the effective tax rate.

The Solution: How to Save up to 62% in Tax

The short answer is to contribute into your pension.

Pension contributions essentially work by sheltering your income from tax. They also have the wonderful benefit of being able to restore your ￡12,570 tax-free Personal Allowance.

If the gross amount that you contribute into your pension in a given tax year is equal to the portion of your income that exceeds ￡100,000, you will have fully restored your tax-free Personal Allowance. This has the effect of getting back the 60% tax that applies on earnings between ￡100,000 and ￡125,140.

When I present this logic to individuals earning over ￡100,000 it can be very difficult for them to follow through with the advice. ￡100,000 after taxes is a little under ￡5,600 net per month and this is simply not enough for many people whose spending has risen in line with their earnings over the years.

There can be very valid reasons to need that much income so I am not here to judge. However I like to point out that, contrary to how so many people behave, real wealth is what you do not spend.

So if you want to become wealthy and benefit from the wonders of compound investment returns, you need to make meaningful sacrifices as early as you can. And what better opportunity is there when the tax incentives are so high?

Now I will give some examples of how this could work.

• Earnings of ￡125,000: A ￡25,000 gross pension contribution would get a total of 60% tax relief if done personally. If carried out instead through an employer's salary sacrifice arrangement, the total relief would be 62% as National Insurance would also be saved.
• Earnings of ￡200,000: A ￡100,000* gross pension contribution would get a total of 48.77% tax relief if done personally. Through salary sacrifice, the total relief would be 50.77% due to NI savings.

*The Annual Allowance for pension contributions is limited to ￡60,000 for the current tax year. However, the above example assumes that there is enough unused Annual Allowance in the three previous tax years available for 'carry forward'.

Warnings & Disclaimers

There are all sorts of restrictions, limits, pitfalls and caveats one should be aware of before paying substantial amounts into their pension. Such details are beyond the scope of this article and I would encourage everyone to seek professional financial advice before taking any action.

This article aims to simplify what can be a very complex procedure and therefore makes a lot of assumptions that probably do not align with the audience's individual circumstances. To be clear, this article does not constitute financial advice.

Thank you for reading and have a great day.