Write to Kate with your pension problem: pensionsdoctor@telegraph.co.uk. Columns are published twice a month on Tuesday mornings
Dear Kate,
As an additional rate taxpayer earning around £130,000 a year, what does the change in the income tax thresholds announced at the Autumn Statement mean for me? Is it worthwhile increasing my pension contributions to reduce my tax bill?
Anon, via email
The good news is that there weren’t any changes to pensions tax, which means that pension savers will continue to get tax relief on their own contributions at their highest marginal tax rate.
Also, there were no changes to the amount you can save into a pension scheme each year or over your lifetime without an additional tax charge.
The lifetime allowance remains frozen at £1,073,100 until April 2026. Although it is disappointing that it was not increased in line with inflation, at least the five-year freeze has not been extended another two years alongside the personal allowance and higher rate tax band changes announced in the Autumn Statement.
Frozen income tax thresholds
The personal allowance of £12,570 and higher rate tax threshold of £50,270 were already frozen until April 2026. In his Autumn Statement, the Chancellor announced that these will now be frozen for a total of seven years until April 2028.
This means many more people will pay income tax for the first time, and middle-income earners will be dragged into higher tax bands as their earnings grow.
There are currently around 5.5 million higher rate taxpayers; by April 2028 it is estimated that this will rise to 8 million.
This fiscal drag, where earnings rise, but tax thresholds do not, will raise billions of pounds for the Government, but reduce people’s disposable incomes – the amount they have available to spend after paying tax.
Additional rate tax threshold
The Chancellor announced radical changes to the 45pc additional rate of tax. This is currently paid by those with taxable income of £150,000 or more.
But from April 2023 the upper threshold will be reduced from £150,000 to £125,140, meaning more people will be taxed at 45pc. But some high earners pay even higher rates of tax.
Those earning over £100,000 a year will lose all or part of their personal allowance. This is reduced by £1 for every £2 of adjusted net income above £100,000, so those earning £125,140 or more, like you, lose their full allowance.
This reduction in the personal allowance makes the effective tax rate a hefty 60pc. This is the triple impact of paying 40pc tax on income over £100,000, losing the personal allowance, and paying 40pc on that income too.
The Institute for Fiscal Studies think tank has estimated that the lowering of the additional rate threshold will mean that around 4pc of adults, or around 2 million people, will be paying 60pc or 45pc income tax by 2027/28. This compares to only around 200,000 people paying the additional rate when it was first introduced back in 2010, and around 629,000 this tax year.
From next April, based on your income of £130,000 a year, this means you will be paying an effective tax rate of 60pc on your income between £100,000 and £125,140, and 45pc on your additional income of £4,860.
Paying pension contributions
Paying pension contributions is an extremely tax-efficient way of saving for your future, as contributions receive tax relief at your highest marginal rate and you benefit from tax-free growth on your investments.
As income tax bands have been frozen, or reduced, paying pension contributions has become an even more important tax planning tool.
They can reduce your adjusted net income so that it falls into a lower tax band, while you still get the benefit of tax relief at your highest marginal rate based on your gross salary.
In your case, paying pension contributions has the additional benefit of partially or fully reinstating your personal allowance of £12,570.
For example, based on your earnings of £130,000 a year, making a personal pension contribution of £30,000 gross would effectively reinstate your personal allowance, and you’d get tax relief at your highest marginal rate on the pension contribution.
The dual impact of a reinstated personal tax allowance and 40pc tax relief on your pension contributions means that your effective rate of tax relief would be 45pc on the first £4,860, then 60pc on the balance.
Salary sacrifice
Alternatively, you could use salary sacrifice to pay personal contributions. This could increase your effective rate of tax relief, as the amount of salary exchanged for a pension contribution is not liable to income tax or National Insurance contributions, as it effectively becomes an employer contribution.
Reader Service: Do you know how much you should pay into your pension? Learn how to boost your pot by consolidating your pensions.
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