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There was an interesting story in the Telegraph last weekend pointing out that the UK tax system is complicated. Before you all stop reading, because you already knew this, stay with us for a moment because research carried out by the mutual insurer, Royal London, has highlighted some interesting anomalies in the system. These anomalies have led to an estimated 775,000 people paying more tax on each extra pound that they earn than someone whose income runs into millions. Concerned? Read on…

This strange situation arises due to the introduction, and subsequent withdrawal, of various allowances at certain levels of income. Successive governments have added to and tweaked these arrangements, creating a number of marginal tax rates. This means that if you are at certain income levels, your tax burden will be greater than it really should be. Affected groups pay these higher rates because as their incomes rise they begin to lose tax, pension and child benefit allowances.

According to Sir Steve Webb at Royal London, “Most people would agree that as people earn more they should pay a higher rate of tax. A series of complex changes which have been bolted on to the tax system over recent years means this is no longer true. There are hundreds of thousands of people who pay more tax on each extra pound that they earn than a millionaire. This is not a sensible tax system.”

What is actually happening is set out below:

  • The first £11,500 you earn each year is free of income tax (although National Insurance starts at £8,164).
  • Your earnings up to £45,000 attract 20% tax, the next band up to £150,000 is 40%, and income above that 45%.

So far, so straightforward. However…

When we have a family with two children, where one person earns between £50,000 and £60,000 a year, the tax rate can be as high as 59.9%. This is because of rules that stop child benefit once at least one half of a couple earns over £50,000. Earning £51,000, for instance, would result in a £179 loss of child benefit. Added to normal income tax and NI rates, the extra £1,000 would result in £599 of “tax”. Royal London estimates 375,000 people fall into this trap.

The next group that are subject to a tax anomaly are those earning between £100,000 and £123,000. The “personal allowance” of tax-free income reduces by 50p for every £1 earned over £100,000. So earning £1,000 over that threshold results in an extra £200 of income tax. The effective tax rate is 62% and is testimated to be paid by 250,000.

Restrictions on the amount you can save into a pension each year have created the next group, estimated to be 150,000 strong. Since April 2016 the “annual allowance” on pension contributions is tapered from £40,000 a year, down to £10,000, for incomes over £150,000.
Like the personal allowance, the pensions limit drops by 50p for every £1 over the limit. Many in this group will be paying top-rate tax, so the annual allowance cut means an extra 22.5% of tax is paid. Taken together, the tax rate is 69.5%.

If you think that your tax affairs are becoming increasingly complicated and would like to talk to one of the team about your tax position, please contact Laura Ford. We’ll get back to you straight away.