Ask the expert: I’m a higher rate taxpayer. Where can I save that won’t result in a big tax bill?
Fidelity International personal finance specialist, Marianna Hunt, helps a taxpayer looking to lower their tax bill.
Q: I’m a higher rate tax payer and likely to become an additional rate taxpayer. I currently hold both a cash and stocks and shares ISA. I also have Premium Bonds and a healthy amount in pensions. Where can I save that won’t result in a big tax bill?
A: First, congratulations.
If you are on the cusp of becoming an additional rate taxpayer, then your salary must be close to hitting £125,140. That is no small achievement.
It is also very positive that you have clearly used your salary to build healthy savings across cash and investments.
The downside is you are probably now in what is known as a ‘tax trap’, where your annual income falls between £100,000 and £125,140.
Not only are you being charged 40 per cent income tax at the higher rate, but for every £2 you earn over £100,000 you lose £1 of your £12,750 personal allowance- an effective tax rate of 60 per cent. Bizarrely, the situation improves when you earn over £125,140, as you only dace additional rate income tax at 45 per cent.
Being an additional rate taxpayer does however mean that you lose your tax-free savings allowance on cash held outside of an ISA. This is £500 for higher rate taxpayers but drops to zero when you earn more than £125,140.
Let’s assume you have already used up your ISA allowance for the year, although if that’s not the case then ISAs would naturally be one of the first options to consider.
Look to your pension
It also sounds like you have healthy cash reserves, so the next place to look would usually be your pension.
Normally, you can contribute up to £60,000 into your pension each tax year and receive tax relief on those contributions. If you do this via salary sacrifice, you get the double benefit of reducing your take-home pay for tax purposes, potentially helping to restore some of the personal allowance that you lose with every £2 you earn above £100,000.
For example, if you earned £110,000 and used salary sacrifice to pay £10,000 extra into your pension in a year, this would bring your pre-tax salary down to £100,000.
This would restore your entire personal allowance, meaning that your post-tax take- home pay only drops from £72,361 to £68,561. Therefore, it would only cost you £3,800 in take-home pay to put an extra £10,000 into your pension.
There are changes afoot that will impact salary sacrifice contributions to pensions, however they aren’t due to come in until 2029.
You might even be lucky enough to have an employer who will match any additional contributions you make into your pension, making that option yet more attractive. Your employer might also allow you to use salary sacrifice to exchange part of your salary for non-cash benefits like leasing an electric car or purchasing childcare vouchers.
If you’ve already used up your pension contribution allowance or don’t want to lock away the money until retirement age, there are other options to consider.
Venture capital and gilts
Venture Capital schemes can offer generous income tax relief. For example, investors in Enterprise Investment Schemes (EISs) can generally enjoy income tax relief at 30 per cent and capital gains tax (CGT) exemptions on qualifying gains.
For Venture Capital Trusts (VCTs), the headline rate of income tax relief is reducing from 30 per cent to 20 per cent from 6 April 2026.
However, these are high risk investments that are only suitable for very confident investors who are comfortable with the potential of losing all their money. Those with a lower risk tolerance could consider more vanilla options, like buying UK government bonds (otherwise known as gilts).
Individuals holding gilts outside of an ISA pay income tax on the income but, unlike many other investments, they do not have to pay CGT when they sell them. If you don’t need a regular income, you could look to buy a gilt that is due to mature in the next few years and is trading on a discount.
That way, most of your return comes from the CGT-free gain you make when the gilt matures.
The returns from UK gilts have historically been quite pedestrian compared with stocks and shares, so you may prefer to open a General Investment Account (GIA) instead.
Unlike with any ISA, any income or profits generated will be taxable, but you may find it more attractive to seek the higher return potential of stocks and shares and accept the subsequent tax bill rather than chasing a lower (but tax-free) gain from UK gilts.
You have not mentioned whether you are married or have children. If either of these is the case, remember that you can contribute to a pension or ISA in your spouse’s name or into a Junior SIPP (self-invested personal pension) or Junior ISA for your child. Being tax-efficient while also giving your loved ones a valuable leg up could be an incredibly rewarding way to put your surplus income to work.
Please remember this is not financial advice. For personalised financial advice, you should speak to a financial adviser.