Understanding the 40% Tax Bracket and Strategies for Efficiency

Celebrating pay rises, bonuses, and new clients is thrilling, but as success grows, the 40% tax bracket may loom. In this article, we’ll explore what the 40% tax bracket entails, the income threshold, and ways to optimise your tax situation.

What is the 40% Tax Bracket?

  • How much do I have to earn to be in the 40% tax bracket?
  • Does the 40% tax bracket ever change?
  • What does the marginal tax rate mean?
  • Will I pay 40% tax on all my earnings?
  • What can I do to reduce my taxes if I’m in the higher rate?

What is the 40% Tax Bracket?

The 40% tax bracket represents the ‘higher rate’ income tax band for individuals earning over £50,270. In the 2023/24 tax year, the rates are structured as follows:

  • Personal allowance: £0 – £12,570 (0%)
  • Basic rate: £12,571 – £50,570 (20%)
  • Higher rate: £50,271 – £125,140 (40%)
  • Additional rate: £125,140 upwards (45%)

How much do I have to earn to be in the 40% tax bracket?

To fall into the 40% tax bracket, your total income must exceed the basic rate, placing you in the higher rate bracket, which spans £50,271 to £125,140 for the 2023/24 tax year.

Does the 40% tax bracket ever change?

While the thresholds for the 40% tax bracket can shift with government decisions, the current personal tax allowances and bands are frozen until 2028. Staying informed about your entitlements and current tax rates is crucial.

What does the marginal tax rate mean?

The marginal tax rate is the tax applied to your highest pound of income. If, for instance, you earn £60,000 per year, your marginal tax rate is 40%, corresponding to the tax bracket for the next pound you earn.

Will I pay 40% tax on all my earnings?

Contrary to a common misconception, hitting a tax band doesn’t mean paying the new tax rate on all earnings. For example, with a £55,000 annual income, you only pay the 40% tax rate on £4,729 of your earnings.

What higher rate tax means for your savings allowance

Entering the higher rate bracket reduces your personal savings allowance from £1,000 to £500. Basic and higher rate taxpayers are entitled to a personal savings allowance.

Strategies to Reduce Taxes in the Higher Rate

Check for Eligible Allowances and Deductions

Explore potential tax allowances and deductions. For instance, married individuals may qualify for marriage allowance, and self-employed individuals can deduct allowable expenses to lower their tax bills.

Evaluate Your Payment Structure

Consider your payment structure. Sole traders may find it tax-efficient to form a limited company, allowing them to take a salary as a director and receive dividend payments from profits.

Explore Savings Accounts and Pensions

Invest in tax-free savings accounts like Individual Savings Accounts (ISAs), where you can save £20,000 tax-free annually. Additionally, contributing to a pension scheme, whether employed or self-employed, reduces taxable income and offers potential tax refunds.

Salary Sacrifice Schemes

Explore salary sacrifice schemes offered by some employers, allowing you to exchange part of your salary for benefits such as additional pension contributions, thereby reducing your taxable income.

Navigating the 40% tax bracket involves understanding the intricacies and employing strategies to maximise tax efficiency. Regularly reviewing your financial strategies ensures you make the most of available opportunities.