We have seen a huge increase in enquiries for final salary pension transfers - this is a very complex area of advice and requires considerable thought before giving up a guaranteed lifetime income. Unfortunately, poor advice has surfaced at British Steel Pension Scheme in South Wales and elsewhere - always choose your adviser carefully!

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Avoiding the Taper Trap – and a 60% income tax charge

The additional rate of income tax in Scotland is 46% for individuals earning more than £150,000 per year. However, there is a category of taxpayer who earns less but pays proportionately more than the super high earners. Some people pay an effective rate of income tax of up to, and over, 60% on part of their earnings. It could be you.

This tax trap revolves around what is known as the “taper trap”. This is where your income exceeds an income threshold that results in you losing certain entitlements. The net result is that you pay more tax.

Two categories of taxpayer fall into the taper trap;

·        Higher earners claiming child benefit

·        Individuals earning over £100,000 per year

Example 1 – Child Benefit claimant

For couples where one partner earns over £50,000 p.a., a high-income child benefit tax charge of 1% applies for every £100 of child benefit awarded.

A family with two children where one partner earns £50,000, would be awarded child benefit of £1,788 per year.  But, should the higher earner receive a pay rise of £1,000, the 1% tax charge on the child benefit would amount to £178. Income tax of £410 (in Scotland) would also be payable. The  tax of £588 on the £1,000 pay increase is equivalent to a 58.8% tax charge.

Example 2 – Earnings over £100,000 per year

Those who have an adjusted net income of over £100,000 p.a. start to lose the tax-free personal allowance of £12,500 ( tax year 2019/20). For every £2 of earnings above £100,000 they lose £1 of tax-free personal allowance meaning that someone who earns £125,000 p.a. has no personal allowance left.

Let us assume you have earnings of £100,000 and you are ‘lucky’ enough to get a £1,000 p.a. pay rise.  As above, income tax at 41% will apply, costing you £410, but you will also lose £500 of your personal allowance.  This means that the £500 personal allowance that was tax free before is now taxable at 41%, which equates to £205.  The total tax due of £615 on your £1000 pay rise is an equivalent income tax rate of 61.5%.

Can this be reduced?

You needn’t despair. Making pension savings can negate the effects of the 60% taper tax trap. Speak to us to find out more and to ensure that you are not inadvertently caught in the trap.