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Will your Personal Allowance be tapered due to earnings in excess of £100,000?

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In the current tax year, (2020/21) the first £12,500 of everyone’s income is tax free (the Personal Allowance).  However, for those earning in excess of £100,000, the Personal Allowance is tapered by £1 for every £2 earned in excess of £100,000.  This means that for those earning £125,000 or more, the entire Personal Allowance is lost.

This means that unfortunately any income earned between £100,000 and £125,000 is effectively taxed at 60%.  This is because the higher rate threshold is effectively reduced to £37,500 (rather than £50,000 when your Personal Allowance is included)

This means that an extra £12,500 is taxed at higher rate (40%) rather than being tax free.  You therefore you pay an additional £5,000 in tax on the same amount of income so for the income between £100,000 and £125,000, you receive £10,000 (effectively 60% tax) rather than the £15,000 that you would normally receive after tax of 40%.

Is there anything I can do about this?

 Yes.  Pension payments act as an income reducer for tax purposes.  If you were to earn £125,000, a personal contribution of £25,000 gross would therefore reduce your taxable income to £100,000 so that you are no longer caught by the taper.  Initially, the cost of the contribution to you would be £20,000 and basic rate tax relief of £5,000 would be added to the contribution so that £25,000 is added to your plan.

You can then claim higher rate tax relief and reclaim your personal so the effective cost of investing £25,000 into your pension is only £10,000 (you effectively get tax relief of 60%).

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