What Is the 40% Tax Bracket?

As your income rises, particularly through promotions, bonuses, or new business ventures, you may find yourself entering the 40% tax bracket, also known as the higher rate of income tax in the UK. But what does this mean for your tax bill?

The UK income tax system divides earnings into different bands:

• Personal Allowance (0%): Up to £12,570 tax-free.
• Basic Rate (20%): Income between £12,571 and £50,270.
• Higher Rate (40%): Income between £50,271 and £125,140.
• Additional Rate (45%): Income over £125,140.

If you earn more than £50,270, the portion of your income above that threshold will be taxed at 40%, until you reach £125,140, where the tax rate rises to 45%.

Will I Pay 40% on All My Earnings?

No, only the amount above £50,270 is taxed at 40%. For example, if your salary is £55,000, you'll pay:

• 0% on the first £12,570.
• 20% on income between £12,571 and £50,270.
• 40% on income between £50,271 and £55,000.

Why Are More People Paying 40% Tax?

Since the UK government froze tax thresholds in 2021-22, the number of people paying higher-rate tax has surged by nearly 2 million. This is because as wages rise, but thresholds stay the same, more people are being pushed into the 40% tax bracket. By 2024-25, it’s expected that 6.31 million people will pay higher-rate tax, a significant jump from 4.43 million in 2021-22.

What Can I Do to Reduce My Taxes If I'm Paying 40% Tax?

If you’ve been pushed into the 40% tax bracket, there are several strategies you can use to reduce your tax bill:

1. Invest in Tax-Free Savings

One of the most effective ways to protect your money from taxation is by investing in an Individual Savings Account (ISA). You can save up to £20,000 annually in an ISA, with all interest or investment income growing tax-free.

Alternatively, consider premium bonds, which allow you to hold up to £50,000 tax-free. While premium bonds don’t offer interest, they do provide the chance to win tax-free prizes ranging from £25 to £1 million.

2. Increase Pension Contributions

Paying more into your pension is one of the best ways to reduce your taxable income. Contributions to a pension benefit from tax relief, meaning they reduce the amount of income that is taxed. For instance, if you are a higher-rate taxpayer earning £60,000 and contribute £10,000 to your pension, you will automatically receive 20% tax relief (£2,000), and you can claim an additional 20% relief through your tax return. This effectively reduces your contribution cost to £6,000, while lowering your taxable income.

3. Use Your Dividend Allowance

For business owners or the self-employed, paying yourself via dividends instead of salary can be more tax-efficient. Dividends are taxed at lower rates:

• 8.75% at the basic rate.
• 33.75% at the higher rate.
• 39.35% at the additional rate.

While dividends avoid National Insurance contributions, they are only paid from profits after corporation tax, and they don't count toward pension tax relief. Be sure to weigh these pros and cons based on your personal circumstances.

4. Share Your Allowances

Couples can reduce their combined tax burden by sharing allowances. For instance, if your partner is a lower-rate taxpayer or has unused personal savings allowances, it may be more tax-efficient to transfer savings or investments into their name. Additionally, non-ISA savings could be shifted to the partner with the lower tax rate to reduce tax on interest.

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