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Earning over £50,271 (the higher rate) or over £125,140 (the additional rate) certainly offers an attractive income. Yet the taxes at these income levels can also be punitive. In some cases, a household’s “real” income (after tax) can be lower than another household where salaries are not as high. For instance, sometimes two parents working part-time can be more tax-efficient than a household with one breadwinner earning over £50,271! In light of cases like this, can you drop an income tax band? Is it a good idea? Below, our Burnley financial planners explore these questions in more detail. We hope this content is useful to you and please contact us if you want to discuss your financial plan with an experienced financial planner in Padiham.
Is it possible to drop an income tax band?
Certainly, it is possible if you change jobs and earn a lower salary! Yet this may not always be desirable or financially astute. For example, suppose you currently earn £60,000, which puts £9,729 of your income into the 40% higher rate bracket (i.e. £3,891.60 in tax). If you change jobs to a £50,000 salary, you avoid paying the £3,891.60 in tax from the 40% higher rate. Yet you are still worse off, in real terms, by £6,108.40.
Things get more complicated, however, when two partners in a household are involved – both potentially working. For instance, suppose one person earns £60,000 and the other person earns £15,000 (e.g. due to working part-time and looking after the children). Compare their tax situation to another household where one partner earns £30,000 and the other earns £35,000. Both households earn the same gross pay, combined (£75,000). Yet the former household will pay more in tax overall. This is because, in the first household, one earner is paying the 40% higher rate on £9,729. In the second household both people pay only the 20% basic rate.
The total income tax liability in household one is £11,917.8. For household two it is £7,972; that is, £3,945.80 lower than the former. This example helps to show that having a higher income as one person does not always translate into higher after-tax income for a household. So, can you drop an income tax bracket and is it sensible to do so?
Should I drop an income tax band?
This is a very personal decision with potential implications for the rest of your budget and wider financial plan. It is wise, therefore, to speak with a financial adviser first about your tax plan to make sure you act appropriately in light of your unique goals and situation. Here are some possible benefits and drawbacks of dropping an income tax band:
- You may not be able to borrow as much when applying for a mortgage.
- If you have “death in service” benefits from your employer, then these may be reduced since they are often based on your salary (e.g. 4x gross pay).
- Your after-tax household income may be improved if you make a joint financial plan with your spouse/partner.
- You may not enjoy the same tax relief from pension contributions as before. A basic rate taxpayer gets 20% tax relief whilst a higher rate taxpayer gets 40% tax relief.
- You may not be able to earn the same amount of tax-free interest as before. Someone on the basic rate can earn up to £1,000 from interest each year, tax-free, using their Personal Savings Allowance. For a higher rate taxpayer, this tax-free limit is £500.
Assuming your financial adviser agrees that dropping an income tax band could be a good idea, what are some ways to do this? One approach is to ask your employer for reduced hours or to move to a 4-day week. Another idea is to explore a “salary sacrifice” arrangement which means taking less gross pay in exchange for certain benefits. These might include childcare vouchers, a life insurance or private medical insurance policy, higher employer pension contributions or other non-cash benefits (e.g. annual leave or “cycle to work” scheme).
Parents should think carefully about how their tax plan could affect their income in light of their childcare costs. Currently, in 2023, UK childcare is the most expensive in Europe and can wipe out a third (or more) of parents’ household income. In many cases, both parents choosing to work part-time and share the childcare of infants and toddlers can be more financially astute than one parent working and one parent staying at home. This is partly because both parents are each entitled to a £12,570 tax-free Personal Allowance on their income. If only one person works, then only one person can enjoy this tax-free allowance (although the non-working person can transfer some of it using the Marriage Allowance). Free childcare may become available to parents with 1 and 2-year olds after the Chancellor announced reforms to childcare provision in the 2023 Spring Statement. However, these are unlikely to be implemented immediately due to the high demand expected. Rather, they may be phased in gradually over the coming years.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
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