“Whilst most people will agree that we pay tax to keep the country running, most of us would be happier if we could find a way to persuade the taxman to take a little less of our hard earned cash.”
There is a simple way for most of us to pay less tax. It is perfectly legal, and all it takes is a little forward planning and making careful tactical use of your pension.
The key to cutting your tax is to understand tax thresholds. Most of us are concerned with two thresholds, the personal allowance threshold, the point at which we start paying income tax, and the higher rate income tax threshold, where tax starts to be charged at 40%.
There is also an additional rate threshold for those earning over £150,000 which sees them paying 45% tax.
The Chancellor confirmed in the recent budget that these thresholds would be revised upwards. The lower, personal allowance will rise from £11,850 to £12,500 from next April. The threshold for higher rate tax will rise from £46,350 to £50,000.
So, for the 2019/20 tax year, if you want to avoid paying 40% tax, you need to be earning under £50,000 a year. You probably don’t want a salary reduction, but there is another way to reduce your taxable salary.
The contributions you make into your pension are deducted from your salary before your tax is calculated. So, in effect, paying into your pension reduces your taxable salary.
So, if you earn £60,000 a year and pay 10%, or £6,000, into your pension, then your taxable salary will be £54,000. This is above the higher rate tax limit, and you will be paying 40% of £4000, or £1,600 to HMRC.
But if your salary is £60,000 and you contribute 17.5% – £10,500 – to your pension, then your taxable salary falls to £49,500. This is below the new higher tax threshold, and you pay 20% tax on all your earnings.
In addition, thanks to the way the pension system works, you will still enjoy 40% tax relief on the relevant contribution, meaning that your £10,500 puts a great deal more into your pension pot.