Higher rate taxpayers: two ways to invest
Tax: an essential part of financial planning
Important information – The value of investments can fall as well as rise, so you could get back less than you invest, especially over the short term. The information shown is not personal advice, if you are unsure of the suitability of an investment for your circumstances please contact us for advice. Once held in a pension money is not usually accessible until age 55 (rising to 57 in 2028). Tax rules change and benefits depend on individual circumstances.
Personal Finance Analyst
Death and taxes: the only two things that we can be certain of, according to Benjamin Franklin. And while it’s not the cheeriest of thoughts, higher taxes have become a mainstay for many individuals in the last decade.
Total higher and additional-rate taxpayers in England is projected to total 3.6 million people this tax year; that’s a rise of 31.6% over the past 10 years.
The equation is obvious if you don’t invest tax efficiently: higher taxes will eat into your investment returns meaning you make less money in the long term.
Scroll across to see the full chart.
Source: HM Revenue and Customs, 28 June 2019
Shelter from the storm
Sheltering your wealth tax-efficiently is a crucial part of financial planning, especially for higher rate taxpayers. And fortunately, the government has a number of ways to incentivise investors to shelter their money from tax.
Here, we highlight a couple of the most popular choices so you can sleep easily, safe in the knowledge that you’re not paying more tax than you need to. Even if you already have a pension and ISA, you might discover that you’re missing a tax saving trick.
Remember tax rules and benefits can and do change and are dependent on your personal circumstances. Once invested in a pension you cannot access the money until at least age 55 (57 from 2028). All investments can fall as well as rise in value so you may not get back what you invest. This should not be viewed as personal advice, should you be unsure of an investment suitability for you, please seek advice.
Personal Finance Analyst
Pensions: your first port of call?
Pensions are naturally top of mind for many saving for retirement – and for good reason. The tax benefits that pensions offer – especially for higher rate taxpayers – make them extremely attractive.
You’re not alone in wanting the most for your retirement – it’s also in the government’s interest that you’re able to retire well.
That’s why when you contribute to a pension, the government gives you an extra boost in the form of tax relief. When you earn tax relief on your pension, some of the money that you would have paid in tax on your earnings goes into your pension pot rather than to the government.
Since tax relief is paid on your pension contributions at your highest rate of income tax, this makes them especially attractive to higher rate taxpayers.
- Basic-rate taxpayers get 20% pension tax relief
- Higher-rate taxpayers can claim up to 40% tax relief (up to an extra 20% claimed back via a tax return)
- Additional-rate taxpayers can claim up to 45% tax relief (up to an extra 25% claimed back via tax return)
The tax bands and rates are slightly different if you’re a Scottish taxpayer.
How tax relief works – an example (based on rest of UK rates)
Robert, Nancy and Dan are basic, higher and additional-rate taxpayers respectively. They all contribute £10,000 into a pension in the 2018/19 tax year. The table below shows the difference in tax relief that they receive assuming they all pay sufficient tax at their highest rate.
|Tax status||Contribution||Tax relief||Total cost|
|Robert||Basic rate taxpayer||£10,000||£2,000 (20%)||£8,000|
|Nancy||Higher-rate taxpayer||£10,000||£4,000 (40%)||£6,000|
|Dan||Additional-rate taxpayer||£10,000||£4,500 (45%)||£5,500|
Why this matters
When you reach your 55th birthday (or your 57th from 2028), you’re free to start withdrawing money from a pension, even if you’re not yet retired. You can usually take up to 25% of your pot tax-free and the rest of your withdrawals will be taxed as your income.
This offers big benefits for many higher rate taxpayers if they become basic-rate taxpayers in retirement. In effect, you would have received tax relief at up to 40% or 45% on your contributions and you’ll only be taxed at the basic rate (currently 20%) on any withdrawals that you make.
The annual allowance
If you’re a UK resident under 75 years old, the general rule is you can contribute as much as you earn to pensions per tax year, after basic rate tax relief has been received, or £3,600, whichever is greater to a pension and receive tax relief.
But there are limits on how much can be paid into pensions in total, this is called the annual allowance and it’s currently £40,000 for most people. Any contributions in excess of this amount will be subject to a tax charge.
Contributions that count towards this £40,000 limit include:
- The money you put in your pension(s)
- The money the government pays in pension tax relief
- Any contributions paid on your behalf (including the contributions your employer puts in)
- Any benefits you build up if you’re in a final salary scheme
If you’re a high earner with ‘adjusted income’ of over £150,000 - your annual allowance could be as little as £10,000. What’s adjusted income? Broadly, it’s your total gross income, plus the pension contributions your employer pays in for you.
Unused allowance from previous years?
While you’re ordinarily limited to putting in up to £40,000 into your pension each tax year, there’s a way you can put in more.
‘Carry forward’ rules mean that you can take advantage of any unused allowance from the previous three tax years. That’s up to £40,000 from each year.
Based on the example below, you could carry forward £50,000 of unused allowance from the previous three tax years and make a contribution of up to £90,000 in the 2019/20 tax year (£40,000 + £50,000). Please note, you’d need to have earnings in the current tax year of at least £90,000 if these contributions are coming from you rather than your employer.
|Tax year||Contributions||Unused allowance*|
*Based on a £40,000 annual allowance in each year.
Available carry forward = £50,000
When looking at the annual allowance you need to consider, whether you or your employer have contributed to multiple pensions or you are/have been a member of a final salary scheme - please download the Annual Allowance & Carry Forward Factsheet for details.
There’s a limit on the total value of pension benefits that you can build up throughout your lifetime without getting a tax charge. Every higher rate taxpayer should be aware of this limit which is called the lifetime allowance and it is currently £1.055m.
Occasions when your pensions are measured against this allowance include whenever you take pension benefits and/or when you turn 75.
This limit was introduced in 2006 at £1.5m and had increased to £1.8m before being gradually reduced to as low as £1 million between 6 April 2016 and 5 April 2018. Since then it has been increased in line with inflation. If you’ve already built up a large pension pot, you might be able to register for protection with HMRC so you can reduce the effect of this limit.
Personal Finance Analyst
The simple tax-efficient investment
Pensions are arguably the most tax-efficient way for higher earners to invest for their retirement. However, with the amount you’re able to contribute to a pension coming down, many higher rate taxpayers are looking for other areas to put the remainder of their annual savings.
The ISA is an obvious choice to consider.
If you’re over 18 and a UK resident, you can contribute up to £20,000 to ISAs this tax year. Pay some, or all, of this into a Stocks and Shares ISA and there’s no UK income or capital gains tax to pay on your investments.
What’s more, as your investments are sheltered from UK tax, ISA investments don’t need to be declared on tax returns making them easy to administer. And although ISAs are designed for long term investments, you can take money out if you really need to. Please ensure you’re making the most of employer pension contributions before looking at other accounts for retirement.
If you’re aged between 18 and 39, you could consider putting money into a Lifetime ISA (LISA).
With a LISA, you can contribute up to £4,000 of your ISA allowance each tax year (up until age 50) and get a 25% bonus from the government. This money can be withdrawn tax free for an eligible first house purchase or after age 60 to compliment any other pension planning.
Other withdrawals will usually mean a 25% government charge, so you could get back less than you put in. You’ll need to have had the LISA open for 12 months before using it to buy a first home.
Since higher and additional-rate taxpayers will receive up to 40 and 45% tax relief on their contributions - and possible top ups from their employer – pensions are often a better option than LISAs for higher earners. But LISAs are worth considering if you’re looking to save tax-efficiently towards your first home or retirement and want an added boost from the government.