Balancing act for those on higher salaries over tax and pension cash

Published on Friday 24 April 2009 21:06

NOW that the Budget secrets are out in the open, higher rate tax payers need systematically to review their financial plans in light of the new rules, writes Valerie Smart.

Firstly, those who risk exceeding the 100,000 income limit above which tax increases will apply from 6 April 2010 should consider – if there is a choice as to when income will arise – taking it in the current tax year.

For example, if a private company pays a cash dividend in 2009-10, the tax bill for a higher rate taxpayer will be 25 per cent, whereas after 6 April 2010 it could be as high as 36 per cent of the amount received.

Although the new 50 per cent income tax rate applicable from 6 April 2010 only applies if income exceeds 150,000, the impact of the withdrawal of personal allowances from 6 April 2010 on incomes above 100,000 will place many taxpayers into a situation where their marginal tax rate is up to 60 per cent for those whose incomes exceed the 100,000 threshold. Understanding these thresholds and planning accordingly is going to be critical in managing tax bills.

There is now a wide gulf between the 18 per cent rate of capital gains tax and the new 50 per cent top rate of income tax, especially as the first 10,100 of gains are completely exempt.

While there is no certainty this gap will continue in the longer term, it is sensible to try to select investments with capital growth in preference to income for those in high tax brackets.

With higher tax rates ahead it also makes sense to transfer as much capital as possible into arrangements where income and gains arise tax free. Those aged over 50 will be able to top up their ISA arrangements to 10,200 after 6 October this year (or 5,100 for cash Isas), with everybody else able to do so from 6 April 2010. The extra six months of tax-free income and gains available to the over 50s is an advantage that should not be spurned, especially by those saving for retirement.

As for higher rate tax relief, the Chancellor announced that the withdrawal of the relief on pension contributions would apply from 6 April 2011 where income exceeds 150,000. But what was not made clear is that many people will be affected by a loss of pension contribution relief from Budget day.

To work out who is affected, it is necessary to look first at whether total income from earnings and investments, less any reliefs, will exceed 150,000 in any of the 2007-8, 2008-9 or 2009-10 tax years. If so, the next stage is to consider if pension contributions made personally or by an employer exceed 20,000. If they do, a special charge of 20 per cent which neutralises higher rate tax relief on pension contributions in excess of 20,000 will apply – unless the contributions are part of a regular pattern. Pension contributions made monthly or quarterly may meet this condition but annual pension payments will not – a trap that will catch many people who top up their pension funds on a yearly basis.

Take an estate agent, who made 160,000 in 2007-8 at the height of the property boom but whose earnings have since fallen to 80,000 as a result of the recession. The estate agent pays 10,000 into his pension fund every year when he knows what his profits are but decides to top up this year to 30,000, in the expectation that 40 per cent tax relief totalling 12,000 will be available in 2009-10. In fact only 10,000 of relief will be given, 6,000 by deduction from the pension premium at source and the rest when his tax return is filed. As the estate agent pays his contribution as an annual premium none of it is protected and the premiums are all classed as non-regular with the excess over 20,000 subject to a special charge of 20 per cent neutralising the remaining higher rate tax relief.

All types of pension arrangement are affected by this new rule, although employees whose pension contributions increase as a result of a routine salary rise will be protected. The tax charge has to be self-assessed on the individual's tax return and this may present problems for employees who are not sure exactly what contributions are made by their employer.

It may come as a surprise to workers who have to pay a tax bill as a result of payments made by their employer directly to their pension scheme. This includes arrangements such as salary sacrifice, where an employee accepts a reduced salary in return for additional employer contributions into their pension.

As always, the Budget small print conceals many surprises. This year, one such example was the decision to withdraw tax advantages from those who rent out furnished holiday lettings from 6 April 2010. Anyone who has income from this source should review their position.

&#149 Valerie Smart is tax director at PricewaterhouseCoopers in Edinburgh.