Working hard and reaping the rewards can be extremely satisfying. Indeed, if your salary or business earnings increase, that’s likely to be welcome news.
However, as your earnings rise, so could your Income Tax liability.
In fact, Money Week has reported that millions of taxpayers may be dragged into a higher salary band due to the freeze on Income Tax thresholds, which is set to remain in place until 2028.
In fact, this is already happening to many earners. According to the Guardian, the number of higher-rate taxpayers rose by almost 2 million between 2021 and 2024.
So, if you’ve had a pay rise or a bumper business year, keep reading to discover practical strategies you could use to remain as tax-efficient as possible when moving into a higher Income Tax bracket.
Boost your pension contributions
Pension contributions are usually deducted from your income before tax if you pay them as part of your salary. Increasing your monthly payments could allow you to boost your tax-efficient retirement savings while keeping your net income below key tax thresholds.
Here are some more important benefits of using your pension to reduce your tax burden.
Benefit from government tax relief
If you’re a higher- or additional-rate taxpayer, you could claim 20% or 25% respectively in tax relief on pension contributions. You’ll need to claim this through your self-assessment tax return.
This is in addition to the 20% relief that all taxpayers automatically receive. So, if you move into the higher-rate tax bracket, you could potentially claim 40% tax relief on contributions to private or workplace pensions. Additional-rate taxpayers can claim 45% tax relief in total.
Manage your business finances tax-efficiently
Moreover, if you’re a business owner, contributing to a pension through a limited company could help you manage higher earnings tax-efficiently. This is because your pension contributions may be treated as an allowable business expense and can even be offset against your business’s Corporation Tax and National Insurance (NI) bill.
Avoid the 60% tax trap
The standard Personal Allowance for the 2024/25 tax year is £12,570. This is the amount of income you can earn before paying Income Tax, and it’s been frozen until 2028.
However, if your earnings exceed £100,000 a year, your Personal Allowance tapers by £1 for every £2 you earn over this threshold. As a result, if you earn more than £125,140, you usually will not be entitled to any Personal Allowance.
This tapering means that the amount you earn between £100,000 and £125,140 could face an effective 60% tax rate, as you may be taxed at the higher rate of 40% while also losing some of your tax-free allowance.
Increasing your pension contributions to keep your taxable income below £100,000 could help you preserve your Personal Allowance and reduce your overall tax bill.
Yet, it’s important to remember that a pension is a long-term investment and your fund’s value may fluctuate and could go down.
Private and workplace pensions are not usually accessible until the age of 55 (rising to 57 from April 2028), so before increasing your contributions, make sure you have sufficient funds to cover short- and medium-term expenses.
Donate to charity
Donating through Gift Aid could allow you to reduce your Income Tax bill while supporting a worthy cause.
Gift Aid is a government scheme that allows charities or community amateur sports clubs to reclaim the basic Income Tax rate of 20% (2024/25) on your donations.
For example, if you gift £100 to charity, the organisation can claim an extra 25p for each pound donated, boosting your donation to £125 – at no extra cost to you.
While the charity benefits from reclaiming the basic rate of 20% on your donation, if you’re a higher- or additional-rate taxpayer you may be able to claim back the other 20% or 25% via your self-assessment tax return.
For example, imagine:
- You donate £1,000 to a charity.
- The organisation claims Gift Aid on your donation, increasing it to £1,250.
- As a higher-rate taxpayer, you could reduce your Income Tax bill by claiming back £250.
Additionally, if you’re a business owner, any qualifying donations you make to charity through your limited company could reduce your profits and potentially lower your Corporation Tax bill.
Read more: 3 practical ways to help a great charity and reduce your tax bill
Combine your tax allowances with your partner
If you’re in a relationship, planning your finances as a couple could help you manage a higher income tax-efficiently.
For example, if you have used your annual ISA allowance and your partner is unable to use theirs before it resets on 6 April, you may want to top up their account.
You can each contribute up to £20,000 to your ISAs in the 2024/25 tax year without incurring Income Tax or Capital Gains Tax (CGT). So, as a couple you could save up to £40,000 tax-efficiently.
Likewise, you are each entitled to a CGT Annual Exempt Amount of £3,000 (2024/25). As such, you could make gains of up to £6,000 on any assets you sell as a couple without paying CGT.
Read more: 6 wonderful benefits of financial planning as a couple
Get in touch
If your earnings have increased, we can help you review your finances and manage them as tax-efficiently as possible.
To find out more, please get in touch. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Approved by Best Practice IFA Group Ltd on 20/03/2025