In England, Wales and Northern Ireland (income tax is devolved to the Scottish Parliament and so the rates are different), the income tax rates for the 2023/24 tax year are as follows:
Income Tax Bandings | |
|---|---|
Up to £12,570 | 0% |
£12,571-£50,270 | 20% |
£50,271-£125,140 | 40% |
£125,140+ | 45% |
Note that you begin to lose your personal allowance by £1 for every £2 that your adjusted net income is above £100,000, which means your personal allowance is zero if your income is £125,140 or above. It’s here you start to pay a considerable amount of income tax.
An ‘approved’ method of reclaiming the personal allowance is to make a pension contribution to take your income to below the threshold at which you start to lose your personal allowance.
If possible, the most tax-efficient method for both employer and employee is to have the employer make a contribution on the employee’s behalf.
Exchanging taxable income for a corresponding employer pension contribution allows you to reclaim your personal allowance and make income tax savings at your highest marginal rate.
Try our Pension Tax Relief Calculator below to see how much you could save.
For the tax year 2023/24 the personal allowance is £12,570, above which income tax needs to be paid. As such, those earning £125,140 or more per year have no personal allowance left to use. This means that some people effectively pay almost 60% tax on income between £100,000 and £123,000.
Tax impact of losing your personal allowance for a salary of £126,000
| |
|---|---|
£26,000 x 40% = £10,400.00 | 59.2%
Effective Tax Rate
100 x (£15,400/£26,000)
|
£12,570 x 40% = £5,028.00 | |
Total = £15,400.00 |
An ‘approved’ method of reclaiming the personal allowance is to arrange with your employer for them to reduce your PAYE salary in exchange for a corresponding employer pension contribution.
Below is an example of someone earning £123,000 who makes no pension contributions. The alternative is for their employer to make a pension contribution of £23,000 and pay a salary of £100,000. This option is known as salary sacrifice or salary exchange.
Employment Income: £123,000
| |
|---|---|
Personal allowance | £76,543.40
Take home (net) pay
|
Taxable income | |
20% income tax on earnings £0 – £37,500 | |
40% income tax on remainder of income | |
Total income tax | |
Employee National Insurance |
Employment income: £100,000
+ £23,000 employer pension contribution | |
|---|---|
Personal allowance | £67,803.40
+ £23,000 pension contribution Take home (net) pay
|
Taxable income | |
20% income tax on earnings £0 – £32,000 | |
40% income tax on remainder of income | |
Total income tax | |
Employee National Insurance |
In addition, the employer also on employer National Insurance contributions, as they don’t need to pay this on employer pension contributions. A generous employer may also pay the amount saved into the pension arrangement.
This example is based on a salary of £123,000 where an individual loses the majority of their personal allowance, and subsequently reclaims the full allowance by taking a proportion of their salary in an employer pension contribution.
The example does not take into account the individual’s personal circumstances or the need to make retirement provisions, nor does it constitute individual financial advice.
Employee (i.e. personal, not company-sponsored) pension contributions can also be used to reclaim at least some of the personal allowance. However, these contributions do not benefit from the employer and employee National Insurance savings.
Employee pension contributions are paid out of post-tax income, meaning income tax and National Insurance contributions have already been deducted on the cash the employee is investing in the pension.
Although making the personal pension contribution still allows the employee to reclaim their personal allowance, it isn’t possible for either the employer or employee to obtain relief on the National Insurance contributions already paid on the sum the employee decides to invest into their pension.
If you’re a higher-rate taxpayer, you’ll also have to apply for your additional 20% tax relief on the pension contribution by applying to HMRC using a self-assessment tax return.
Moreover, an employer can apply for corporation tax relief as a business expense on pension contributions they make on behalf of their employees, as well as not having to pay National Insurance contributions on the sum invested into a pension. This is because employer pension contributions aren’t PAYE income that goes through payroll.
So while the employee can make pension contributions out of their post-tax income and reclaim their personal allowance, it isn’t as tax efficient for either party as having the employer make the contribution.
This example is based on a director of their own company remunerating themselves with a fairly small salary (£23,000) and the bulk of their income made up of dividends (£100,000).
The individual is a higher rate taxpayer and therefore pays a higher rate of tax on their dividends. Also, as their income is over £100,000, their personal allowance has been reduced to £1,000.
Gross income: £123,000
| Gross dividend income: £100,000 | Gross PAYE salary: £23,000 |
|---|---|
Dividend allowance | Personal allowance |
Taxable dividend income | Taxable PAYE income |
Dividend tax | 20% income tax on earnings £0-£32,000 |
Total dividend tax | Employee NI contributions |
Take home (net) pay: £87,851
| |
The individual is a higher rate taxpayer, but their personal allowance has not been reduced as they are putting £23,000 into a pension.
Gross income: £100,000
+ £23,000 employer pension contribution
| Gross dividend: £77,000 | Gross PAYE salary: £23,000 |
|---|---|
Dividend allowance | Personal allowance |
Taxable dividend income | Taxable income |
Dividend tax | 20% income tax on earnings |
Total dividend tax | Employee NI contributions |
Take home (net) pay: £77,788.50
+ Pension contribution: £23,000 | |
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