Reader's Question
My salary is £75,000 with a target bonus of 50%, taking me over the £112,000 cap and will lose my personal allowance. Can it work if I only take bonus up to £99,000 and have the company pay the rest of the bonus into the pension scheme thereby keeping my personal allowance?
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My response
Hi,
Good question.
To give other readers a bit of background, while most people receive an income tax ‘personal allowance’, which is an amount of money they can earn before paying tax, those earning over £100,000 a year lose it.
The amount of your personal allowance depends on your age and your total income during the tax year. The personal allowance for someone under 65 is £7,475 for the 2011/12 tax year. But the personal allowance reduces where an individual’s income is above £100,000 – by £1 for every £2 of income above the £100,000 limit. This reduction applies irrespective of age.
That means that someone who is, for example, under 65 and earns more than £114,950 for the 2011/12 tax year will lose their personal allowance in its entirety. This gradual withdrawal of the personal allowance means that a person’s earnings between £100,000 and £114,950 are effectively taxed at an eye watering 60%. One thing to point out is that your total earnings will equal £112,500 so you technically won't lose all of your personal allowance, but admittedly most of it.
But there is a way around this as I mention in my Money tip #128 – The 60% income tax trap and how to avoid it.
The personal allowance withdrawal technically relates to something called the ‘adjusted net income’ and not your gross salary. For a lot of people these may be one and the same. But the ‘adjusted net income’ used in the withdrawal calculation is an individual’s income which is subject to income tax less specified deductions, which include grossed up contributions to pensions as well as grossed up contributions to charities via gift aid.
So if you keep your 'net adjusted income' below £100,000 you will receive your full personal allowance. As you allude to, you should be able to reduce your net adjusted income below £100,000 by either you or your employer paying into a pension. But the advantage of getting your employer to pay the a pension contribution, via some form of salary sacrifice, is that they will save in National Insurance Contributions and you could negotiate that they pay that into your pension pot as well.
So if like you suggest, you reduce your net adjusted income to £99,000 this will mean that your net take home pay will drop from £69,359 to £64,029. A difference of £5,330. Now if your employer pays £13,500 into your pension plan plus their saving in NICs (£1,863) this would total £15,363.
What this means is that the pension contribution of £15,363 costs you £5,330, an effective tax relief of over 65%!
Wow.
I hope that helps
Best Wishes
Damien
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