How to pay less tax: high earners

Published by Sam Barrett on 21 March 2011.
Last updated on 24 August 2011

With the country in the grip of austerity measures, you can be sure that most of us will see our tax bill rise in April. But, while some of it's unavoidable, there are steps you can take to ensure you don't hand over more than you need to.

Tax rises will see the taxman receiving much more of every pound you earn. As an example, if you're a basic-rate taxpayer, for every £1 you earn over the £7,475 personal allowance, the taxman will get 20p in income tax.

On top of that, HM Revenue & Customs (HMRC) will receive 12p in employee national insurance and a further 13.8p in employer national insurance. That's a total of 45.8p so far for the taxman, 32p of which has come out of your pocket.

Then, if you spend the 68p you have left on something that's subject to VAT, HMRC will get a further 11.3p. This means the taxman could end up taking 57.1p of every £1 you earn.

Simply refusing to pay tax isn't possible without breaking the law, but figures from professional advice website show we're wasting billions of pounds in unnecessary tax. This includes £328 million in income tax; £552 million in capital gains tax; almost £2 billion in inheritance tax (IHT); and £3.9 billion in unclaimed child and pension credits.

The average UK taxpayer wastes an estimated £186 a year in unnecessary tax payments.

In the third part of our series, we show higher-rate tax payers how to keep as much of your money as possible in your pocket and out of the taxman's clutches.

Case study: A high earner looking to the future

Max Mitchell, a 41-year-old solicitor, is feeling the squeeze on high earners. He earns £140,000 and will see his net pay drop by £1,501.44 this year as a result of changes in tax and national insurance.

However, while Max is taking less money home, there are a number of tax breaks he can take advantage of to make up for it.

Max's solution...

Stephen Herring, senior tax partner at BDO, says Max should look closely at his pension. "The anti-forestalling rules have restricted many people's pension contributions to £20,000, but the new carry-forward rules, coupled with the £50,000 annual pension limit, mean he could pay in £110,000 in the 2011/12 tax year - £50,000 for the year plus two lots of up to £30,000 of unused allowance from the two previous years," he says.

Although it may be worth playing catch-up with his pension, Herring recommends caution: "The lifetime limit is dropping from £1.8 million to £1.5 million from April 2012, with any excess hit with an effective tax charge of 55%.

"If you think your fund will grow to more than £1.5 million by the time you retire, you can elect to freeze contributions after April 2012."

As an alternative, or in addition, Max could consider tax-efficient investments. ISAs are a good starting point, but he could also consider a venture capital trust (VCT) or an enterprise investment scheme (EIS) as both offer generous tax breaks.

From an income-tax perspective, a VCT gives you 30% relief on investments up to £200,000, while an EIS provides 20% relief on investments up to £500,000; but you need to hold them for at least five and three years respectively. This means that if Max pays £20,000 into a VCT, he'll get £6,000 to offset against his income tax bill.

On top of that, neither are liable for capital gains tax (CGT) (subject to three-year holding for EIS): VCTs pay dividends tax-free and EISs are exempt from inheritance tax after two years. 

But Herring warns against focusing solely on the tax breaks: "They are there to channel money into higher-risk trading businesses. Max should make sure what he gains in tax relief isn't swallowed up by poor performance."     

More generally, if capital gains on his investments are an issue, Herring recommends Max sells assets each year to make sure he doesn't go over the annual CGT allowance (£10,100 in 2010/11). 

Getting the basics right

While complex planning can save you thousands in tax, it's also worth paying attention to the basics such as your tax code and tax credits. This guide will help you get the basics right.

• Check your tax code by looking at your pay slip or asking your tax office for a coding notice. This will detail your allowances and any deductions due to state benefits or taxable employee benefits.

If it doesn't look right, query it - any errors will affect how much you pay or potentially result in a large tax demand if you're paying too little.

Given the size of most of our tax bills, it's probably no surprise that some of us pay too much. This can happen if you change jobs and your correct tax code isn't used, or if you have more than one job. If the overpayment relates to the current tax year, contact your tax office as it'll be able to adjust your tax code.

If an overpayment relates to a previous year, write to your tax office with your P60 and details of your income. You can claim back overpaid tax for up to six years, although this is reducing to four years in April 2012. 

• You can also pay too much tax on your savings as tax on interest is deducted at source. If this has happened, complete a form R40 Tax Repayment Form for each year you've paid too much. A form R85 from your building society or bank will stop future interest being taxed.

• Another basic that can affect your overall financial position is tax credits. Nine out of 10 families with children are entitled to tax credits and any pensioner receiving less than £137.35 a week (£209.70 for couples) can get pension credit. A benefit-checker such as that provided by Turn2us can help you claim your entitlement (

April 2011 - the key changes

Income tax

Tax rates remain the same but there's an increase in the personal allowance from £6,475 to £7,475. There's also a reduction in the threshold for higher-rate tax (£35,001 down from £37,401).

Older people see smaller increases in their personal allowances: if you're between 65 and 74, it goes up from £9,490 to £9,940, and if you're 75+, up from £9,640 to £10,090.

National Insurance

Rates are increasing in April. Employee and employer contributions increase by one percentage point, to 12% and 13.8% respectively. Additionally, the employee rate on earnings above the upper limit also increases from 1% to 2%.

Self-employed people will also see an increase, from 8% to 9%, and from 1% to 2% for the upper level. 

Inheritance tax

The nil rate band is frozen at the amount introduced in 2009/10: £325,000.

Basic State Pension

The full basic state pension rises from £97.65 to £102.15 a week.

Tax credits

Tax credits will be reduced for families earning over £40,000; low-income families will receive more child tax credit.

Fuel duty

A 0.76p per litre increase came into force in January 2011, with a further rise due in April.

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