You will know that the personal allowance is the amount of annual earnings that your employees can earn before paying any income tax. For the 2020/21 tax year, this is £12,500. People with income of over £100,000 see their Personal Allowance go down by £1 for every £2 of income over £100,000. This means that those with income of over £125,000, have no personal allowance at all.
Whilst technically the tax rate is 40% from £50,000 to £150,000 (at which point the income tax rate increases to 45%), the removal of the Personal Allowance means that from every £100 of income between £100,000 and £125,000, an employee only sees £40 in their take home pay (£40 due to 40% income tax and £20 due to the impact of the gradual removal of the Personal Allowance). This could be viewed as an effective rate of income tax of 60% - which could be seen as a disincentive for staff to push for that promotion or secure higher bonuses through hard work.
Tax on income is not the only area of concern for people with earnings of this level – there can also be an impact on childcare. Under the tax-free childcare system, the Government will top up every £8 payment into the user’s online childcare account with a further £2. This account is then used to pay for approved childcare spending on under 12s by up to £2,000 per child per year – although households where one parent earns more than £100,000 in a year will not qualify. These families will also be excluded from the 30 free hours per week of childcare scheme that is available for three and four-year olds.
Is there anything we can do about this?
It is possible to take action to ensure that your staff do not find themselves in this situation. One way is to remove those taxable earnings by exchanging them for something else that isn’t taxable.
Pensions is an obvious option. Should someone who is not making any pension contributions at all have earnings of £110,000, they would have take-home pay of £70,440 (paying £33,500 in tax and £6,060 of National Insurance). This is based on the person’s personal allowance being reduced to £7,500 due to their earnings being £10,000 above £100,000. It would mean that they would have a total remuneration of £70,440 from that employment – all of which is paid into their bank account.
However, should that same person enter into an agreement with their employer to sacrifice £20,000 of their pay in exchange for an employer pension contribution of the same amount (a method we refer to as “salary exchange”), they would see their take home pay change to £60,840 (paying £23,500 in tax and £5,660 in National Insurance). It would mean that they would have a total remuneration of £80,840 from that employment – £60,840 paid into their bank account, with £20,000 paid into their pension.
These agreements need not be only with respect to regular salary – they can be used for bonusses too.
Another option is a cycle to work scheme – For example, should your employee sacrifice £1,000 through the cycle to work scheme, the impact on their take home pay would be £400, and they would benefit from owning a bike worth £1,000! Should an employer apply for FCA authorisation, it is possible for bikes over £1,000 in value to be included too.
Where can I get further help or advice on this?
If you would like further information or advice on how to approach this issue, please email Brunsdon Financial via firstname.lastname@example.org .
Alternatively, you can visit the Government’s website.
Please note that the value of investments can fall as well as rise. You may not get back what you invest.
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Any information provided in this article regarding tax treatment or legislation is based on our understanding of current UK legislation law, tax law and HM Revenue and Customs’ practice (August 2020), all of which may be subject to change.