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Ask the Expert: Tax-Efficient Savings for High Earners
Fidelity personal finance specialist, Marianna Hunt, addresses a pressing question from a taxpayer seeking to minimise their tax burden while maximising savings potential.
The Taxpayer's Dilemma
Q: I'm a higher rate taxpayer and likely to become an additional rate taxpayer soon. I currently hold both a cash and stocks and shares ISA. I also have Premium Bonds and a healthy amount in pensions. Where can I save that won't result in a big tax bill?
A: First, congratulations on your financial success. If you are on the cusp of becoming an additional rate taxpayer, your salary must be approaching £125,140, which is a significant achievement. It's commendable that you've built robust savings across cash and investments. However, you may find yourself in what's known as a 'tax trap', where annual income falls between £100,000 and £125,140.
In this bracket, not only are you charged 40 per cent income tax at the higher rate, but for every £2 earned over £100,000, you lose £1 of your £12,750 personal allowance. This creates an effective tax rate of 60 per cent. Interestingly, the situation improves once earnings exceed £125,140, as you then face the additional rate income tax at 45 per cent.
Becoming an additional rate taxpayer means losing your tax-free savings allowance on cash held outside an ISA. This allowance is £500 for higher rate taxpayers but drops to zero when earnings surpass £125,140. Assuming you've already utilised your ISA allowance for the year, we need to explore alternative avenues.
Prioritise Pension Contributions
Given your healthy cash reserves, the next logical step is to examine your pension options. Typically, you can contribute up to £60,000 into your pension each tax year and receive tax relief on those contributions. Utilising salary sacrifice offers a dual benefit: it reduces your take-home pay for tax purposes and can help restore some of the personal allowance lost when earning above £100,000.
For instance, if you earn £110,000 and use salary sacrifice to contribute an extra £10,000 to your pension annually, this reduces your pre-tax salary to £100,000. This action restores your entire personal allowance, meaning your post-tax take-home pay only decreases from £72,361 to £68,561. Essentially, it costs you just £3,800 in take-home pay to add £10,000 to your pension.
Note that changes to salary sacrifice contributions for pensions are scheduled for 2029, but current arrangements remain advantageous. Some employers may match additional pension contributions, enhancing this option's appeal. Employers might also permit salary sacrifice for non-cash benefits like electric car leases or childcare vouchers.
If you've exhausted your pension contribution allowance or prefer not to lock funds away until retirement, other strategies are available.
Explore Venture Capital and Gilts
Venture Capital schemes can provide generous income tax relief. Investors in Enterprise Investment Schemes (EISs) often enjoy 30 per cent income tax relief and capital gains tax (CGT) exemptions on qualifying gains. For Venture Capital Trusts (VCTs), the headline income tax relief rate is reducing from 30 per cent to 20 per cent from 6 April 2026.
However, these are high-risk investments suitable only for confident investors comfortable with potential total loss. For those with lower risk tolerance, more conventional options like UK government bonds (gilts) are worth considering.
Individuals holding gilts outside an ISA pay income tax on the income but are exempt from CGT when selling them. If regular income isn't needed, purchasing a gilt trading at a discount and maturing in the coming years could be beneficial. This approach allows most returns to come from the CGT-free gain upon maturity.
Historically, UK gilt returns have been modest compared to stocks and shares. You might prefer opening a General Investment Account (GIA), where income and profits are taxable but offer higher return potential. Accepting a subsequent tax bill might be more attractive than pursuing lower, tax-free gains from gilts.
Consider Family-Focused Options
You haven't mentioned marital status or children, but if applicable, remember you can contribute to a pension or ISA in your spouse's name or into a Junior SIPP or Junior ISA for your child. This strategy is tax-efficient and provides valuable support for loved ones, making it a rewarding way to utilise surplus income.
Please remember this is not financial advice. For personalised financial advice, you should consult a qualified financial adviser.
