Money helpdesk: Options open on trimming your pay to ease tax burden

Q AS A director of a small engineering firm, my annual income is over £100,000 a year. I know that the personal tax allowance rates are changing. Is there any advice you can offer to mitigate the loss of my allowance above £100,000?RH, Aberdeen

A The annual allowance for the tax year 2010-11 remains unchanged at 6,475. But the personal allowance for individuals with an annual income of 100,000 or more will reduce by 1 for every 2 over the 100,000 threshold, under changes that came into force with the new tax year on 6 April. The change to the personal allowance is best illustrated by the following two scenarios:

• Individuals earning 112,950 a year will not have the personal allowance available to them when calculating their income tax. As a result, basic tax will be levied at 20 per cent on the first 37,400 (7,480) and the remaining 75,550 will be subject to tax at 40 per cent (30,220), bringing the total tax liability to 37,700.

• In comparison, those with an annual income of 100,000 will benefit from an annual personal allowance of 6,475. They will be subject to basic rate tax on 37,400 at 20 per cent (7,480) and higher rate tax on 56,125 at 40 per cent (22,930). The tax liability will total 29,930.

Therefore, the tax liability on the additional income of 12,950 is 7,770. Effectively, this works out to be a marginal rate of tax of 60 per cent on every 1 of the first 12,950 above 100,000.

To make full use of the personal allowance, individuals will need to keep their income below 100,000. Keeping the income between 100,000 and 112,950 will also have beneficial tax impact. Opportunities exist to keep the personal allowance, or part thereof, and benefit from the attaching tax savings. A relievable personal contribution to a pension scheme operating relief at source (ie personal pension) remains an effective method of changing your net income.

A net personal pension contribution of 10,360 will adjust an annual income of 112,950 to 100,000. By doing so, the individual will ensure that they keep their full personal allowance. It will also reduce the higher rate tax liability by 2,950.

Employees who are able to make use of salary sacrifice through their employment (group) pension schemes could reduce their annual income to 100,000 in lieu of an employer pension contribution. In instances where the employer passes on the National Insurance savings to the employee, this can result in even higher savings. This will become even more attractive fron April 2011 with NI rates set to rise by 1 per cent.

Investment bonds can offer an effective way of deferring a tax liability and do not produce further taxable income, ie interest and dividends, which would further increase the total annual income.

• Christian Poziemski is a financial adviser in the private client and financial services division of HBJ Gateley Wareing.

• If you have a question you need answered, write to Jeff Salway, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or e-mail: [email protected].

• This above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.