What is the 40% tax bracket?

As your business and income grow, so can your personal tax bill. Knowing how much income tax you’ll pay is important for budgeting and tracking.

In the UK, there are various tax brackets depending on income level. The 40% tax bracket is one of those brackets and depending on what you earn or income from all sources during a tax year, the 40% tax rate could be payable on part of your income or salary.

In this blog, we’ll explain UK tax brackets and when you may hit the 40% tax bracket, what this means for your tax bill and also give you some tax savings strategies to minimise your tax bill.

What you need to know about the UK tax system

In the UK, individuals pay income tax on their total income within a tax year (Note: the UK tax year runs from 6 April to 5 April each year). The tax rates are broken down into different bands, and a personal allowance allows you to earn a certain amount before you are liable for income tax.

Every individual has a tax-free personal allowance of £12,570. This means you can earn up to this pre-tax income in a tax year without being liable for any income tax. It’s vital to remember that this is calculated around income from all sources which could be a combination of salary or self-employed income and things like interest from savings and investments or rental income.

Note: Dividend income is not included in your income tax bands calculation as dividend income is taxed at dividend tax rates, which are lower than income tax rates.

There are currently three main UK tax thresholds and bands: The basic rate (20%), also known as the lower tax bracket, the higher rate (40%) and the additional rate tax band (45%). The tax band you are in depends on your overall taxable income in a tax year. Please take a look at the table below.

Note: You do not get a personal allowance if your taxable income is over £125,140 per tax year.

How much personal allowance you are entitled to could vary depending on your overall taxable income. Your personal allowance decreases if you have an annual income greater than £100,000. For every £2 you earn over £100,000, you lose £1 of your tax-free Personal Allowance.

What is the 40% tax bracket?

As you can see above, the 40% tax bracket is one of four in the UK. It is known as the ‘higher rate’ income tax band for individuals who earn between £50,271 and £125,140 in annual income.

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

To hit the 40% tax bracket when your total annual income for the tax year exceeds £50,271.

The higher rate of income tax will be charged for income between £50,271 £125,140. (Note that these are the 2024/25 thresholds; check each year as they may be subject to change by the Government.)

This means that income within this bracket will be taxed at 40%, and income over £125,140 will be taxed at 45%.

Will I pay 40% tax on all my earnings?

No, nobody pays 40% tax on all of their earnings. People often think that when they’ve hit the £50,271 threshold, they will pay tax in the higher rate tax band at 40% on all of their income, but this is not the case. See the example below.

For example,

If you earn an annual income of £75,000 each tax year, you’ll pay the following:

0% tax on the first £12,570 earned because of the tax-free standard personal allowance

20% tax on earnings between £12,571 - £50,270

40% tax on earnings between £50,271 – £75,000

Therefore, you’re only paying the 40% tax rate on £24,729 of your earnings.

Does the 40% tax bracket ever change?

The UK Government holds an annual Budget, announcing any tax changes it intends to make. This means the thresholds for the 40% tax bracket can change depending on Government decisions and policies, so it’s worth checking each year to see if they have changed. At the moment, the current personal tax-free allowance and tax bands are frozen until 2028.

Understanding marginal tax rates

The marginal rate of tax paid is the percentage of tax paid on earnings for the next pound you earn. For example, if you earn £55,000, your marginal tax rate is 40%. That’s because the next pound you earn will be taxed at 40%.

Tips on reducing your higher rate income tax bill

If you are approaching or are already in the higher tax bracket, it’s worth considering whether you can save tax by reducing your taxable income with some tax-saving ideas.

Seek professional advice, from accountants such as dns accountants to get bespoke tax planning advice.

However, it’s worth familiarising yourself with just some of the ways you can achieve a tax reduction through the use of certain tax reliefs and tax allowances. Here are some ways to reduce income tax and potentially drop into a lower tax bracket.

Use relevant tax allowances or deductions

You may be entitled to certain tax allowances. Examples of UK tax allowances are things such as marriage allowance if you are married, or blind person’s allowance if you are blind. If you are self-employed, deductible expenses can reduce your taxable income.

Other tax-free allowances that may be used are:

• Savings allowance - You may also be eligible for up to £5,000 of interest on savings that you do not have to pay tax on. This is your starting rate for savings. However, the more you earn from other income (for example, your salary or pension), the less your starting rate for savings will be.

• Dividend income: if you own shares in a company, you can pay yourself a combination of dividends and salary, which can be tax efficient. You can earn some dividend income each year without paying tax.

  Dividend tax is not payable on dividend income that falls within your Personal Allowance (the income you can earn each year without paying tax).

  You also get a dividend allowance each year. You only pay tax on any dividend income above the dividend allowance. The dividend allowance for the tax year 6 April 2024 to 5 April 2025 is £500.

You could also benefit from tax-free allowances for:

• Your first £1,000 of income from self-employment - this is your ‘trading allowance’

• Your first £1,000 of income from property you rent (unless you’re using the Rent a Room Scheme)

You can also claim different types of tax allowances and relief for Capital Gains Tax.

Pension contributions and employer pension schemes

Paying into a pension will help you to reduce your tax bill and will improve your long-term finances. Saving into a pension could be particularly tax efficient.

Pension payments reduce your taxable income. This is because pension contributions are free from income tax. This means that when you pay money into a pension, you will be refunded the income tax that you initially paid on that money.

Tax-efficient savings and investments

By using the savings allowance alongside pension contributions and ISAs, many people can minimise or avoid paying tax on their savings interest.

Individual Savings Accounts (ISAs) allow you to save and invest tax-free. Every individual has an ISA allowance each year, allowing them to invest up to £20,000 tax-free. To save on behalf of a child, you can also open a Junior ISA to save an extra tax-free sum. You can save up to £9,000 in a Junior ISA tax-free for the current tax year.

There are different types of ISAs in which you can invest your savings income: cash ISAs, stocks and shares ISAs, lifetime ISAs, and Innovation Finance ISAs.

Children’s pensions allow you to save up to £2,880 into a pension for your child. The government will top this up with an extra £720 in tax relief. However, the child won’t be able to access the money until they are 57.

Charitable contributions

You can claim tax relief on your charitable donations. If you are a higher-rate taxpayer, you can claim the difference between the rate of tax you pay and the basic rate on Gift Aid donations. Gift Aid allows you and the charity to get additional money each time you donate. To claim tax relief, declare charitable contributions on your tax return.

The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

Investing in the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS). Both these schemes can lead to substantial tax relief.

EIS investments allow you can claim up to 30% income tax relief on the amount invested if you keep the investment for a minimum of three years. Any gains are free from Capital Gains Tax if the shares are held for at least three years.

SEIS investments allow you to claim up to 50% income tax relief on the amount invested if you keep the investment for a minimum of three years. Gains are also free from Capital Gains Tax if the shares are held for at least three years.

Claiming Allowable Expenses

If you are self-employed or a sole trader, claiming allowable expenses can reduce your tax bill. Expenses incurred ’wholly and exclusively for business purposes’ such as stationery, office equipment, travel, and marketing costs, can be deducted from your profits/income.

You can find out more about what business expenses you can claim when self-employed or a sole trader here.

Paying dividends

If you run a limited company, you should pay yourself using a combination of salary and dividends to obtain the most tax efficiency and reduce your income tax bill. Find out more about dividends here.

How dns accountants can help to minimise your income tax bill

Personal tax planning is essential for directors of companies and individuals with multiple income streams, for example, income from rental properties and/or other investments.

Tax planning can save you thousands of pounds, whether you are a sole trader or a limited company.

We can work with you to ensure you stay compliant but pay the least tax possible. Effective tax planning is done over a period of time, and although we can begin immediately to save you tax, over several years, we can minimise your liability. We can also advise you about the best business structure to ensure you pay the least tax and then put in place the structure to minimise your liability.

For help and advice on saving tax and tax planning contact us today at 033 0088 3616, email or book a free consultation.

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