How can I avoid going into the 40% tax bracket?

Question

I currently earn just below the 40% income tax threshold and have two questions. Firstly, I am likely to get a bonus at work, does that count as part of my main income as it would push me into the higher tax bracket? Secondly, even a small pay rise is likely to move me into the 40% rate. Can I do anything to offset it? For example, pay the excess straight into my company pension?

From

DS/Ripon

Congratulations on getting a bonus, this is good news. The bad news is that it will be taxed as earnings in exactly the same way as your income, so will be potentially liable to income tax at your marginal rate and national insurance contributions. This means that the amount of extra money you get in your pocket may be less than you think as you’ll be paying more tax.

There may be other disadvantages – for example, if you receive child benefit and your income increases to more than £50,000 a year. In this situation, there is an income tax charge of 1% of the amount of child benefit received for every £100 of income over £50,000. So those earning a net income of £60,000 or more will effectively lose all of their child benefit.

There are ways that you can reduce your income for tax purposes, the most common of which is to invest into a pension. The money you invest can potentially benefit from tax relief of 40%, compared with 20% for a basic-rate taxpayer. This can reduce the amount of income tax you pay on your earnings and bonus and protect your entitlement to child benefit if you are affected.

You need to be aware of tax changes planned from 6 April, such as the personal allowance increasing to £12,500, which means people will have more tax-free income and the higher rate threshold rising to £50,000, meaning fewer people will pay income tax at the higher rate.

This latter change might mean you are not pushed into a higher tax bracket after all, depending on the amounts in question. These changes apply in England and Wales; there are different tax rates in Scotland. Visit Gov.uk/scottish-income-tax for more details.

Tax rules can be confusing, so if you’re not really sure what you’re doing, you should take independent financial advice.

Patrick Connolly is a certified financial planner at Chase de Vere

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