PAYE Tax Optimisation
Matt McCorry, 10 months ago
Optimising Tax as a Salaried Employee
The is much information as to how one can minimise tax due when working via a limited company, but there is limited information available on how to optimise as a salaried employee, e.g. full-time, fixed contract or umbrella.
I am to show some ideas that can be used in order to reduce tax liability, whilst paying what is due.
The tools available to an employee to flex income are limited. They consist of salary sacrifice, pension and a few smaller options, and part-time working.
Income tax is levied based mostly on annual earned income. The tax rates and bands can move slightly, but there are 4 generally accepted tax bands: 0%, 20%, 40% and 45%. This view is slightly misleading, as earnings at the top of the 40% tax band reduces the 0% tax amount, causing an effective 60% tax band plus National Insurance, but we will come back to NI later.
So our tax bands for the 2023/2024 year are:
- 0% £0 to £12,570
- 20% £12,571 to £50,270
- 40% £50,271 to £100,000
- 60% £100,000 to £125,140
- 45% £125,141 and up
Note that the tax rate increases, then decreases again. Normally, one would expect that the minimal tax would be due by taking the same salary every year, avoiding unnecessary incursions into a higher tax band. However, due to the increasing and decreasing tax rate, this theory no longer applies at these higher income levels.
We can experiment using two scenarios: one where the person is paid £120,000 (plus £20,000 pension sacrifice) a year for 4 years, and the other where the person uses an oscillating salary of £100,000 plus £20,000 pension, £140,000 plus £0 pension, repeating for the 4 years. Average salary is £120,000 in both scenarios, but there is a different in post tax salary in the year 2022/2023:
|Method||Calculation||Total||Average Per Year|
|Equal||4 * £73,310.13 =||£293,240.52||£73,310.13|
|Oscillating||2 * £83,628.52 + 2 * £65,960.13 =||£299,177.30||£74,794.32|
The difference between the two schemes is Oscillating winning by £1,484.19 a year on average. This is a simplified example, it makes no account of annual increases, changes to bands, changes to rates, or anything else, but it does demonstrate that it is possible to reduce taxation by being aware of inconsistencies within the bands.
National Insurance is done on weekly income rather than annual income, however due to payroll constraints you will normally see if levied on a monthly level.
Employee NI Bands:
- 0% £0-£1048
- 12% £1,048.01 to £4,189
- 2% Over £4,189
The structure of a reducing tax has appeared again. As we have seen, an efficient way to navigate this is to oscillate the salary around the high tax rate band.
We can achieve this again using pension sacrifice, and loading it heavily into certain months to allow the pension contribution to reduce tax due in the 12% band.
Imagine an employee earns £66,000 a year, £5,500 a month. They sacrifice £1,000 a month into their pension, they will save 2% NI tax on their pension contributions. Salary portion of the pay is £54,000.
What if the employee was to squeeze these contributions into as few months as possible? What if the employee sacrificed £4,000 each month for 3 months, leaving them taking home £1,500 (roughly minimum wage)? This would allow the employee to access 12% NI savings for a portion of their contributions.
|Equal||12 * £426.37 =||£5,116.48||12 months of £54,000 a year|
|Variable||9 * £458.87 + 3 * £59.96 =||£4,309.71||9 months of £66,000 a year, 3 months of £18,000 a year|
The variable provides a saving of £806.77 for the year
Again this scenario is simplified, often employees will have a monthly salary sacrifice to get a match from their employer, but this method is possible with additional contributions. The employer's NI dues are unaffected as they are a flat 12%. This should not affect the year's pension contribution as we are earning enough, but I would check to be on the safe side. Doing this may also have some negative consequences, it will interfere with your income tax calculations, as payroll will be expecting your annual salary to be higher than it is. Try to avoid taking the low salary at the end of the tax year, as it will be harder to correct. If you change your pension too frequently, it may upset the payroll workers, but it depends on how automated they are.
This method becomes less efficient the higher the monthly income, as the employee must sacrifice more income at 2% in order to reach the 12% slice.
Higher income, £140k/year, £20k pension sacrifice contribution
|Equal||12 * £605.12 =||£7,261.48||12 months of £120,000 a year|
|Variable||10 * £659.29 + 2 * £82.04 =||£6,756.98||10 months of £140,000 a year, 2 months of £20,000 a year|
This is a subject I have not seen discussed elsewhere. I think I have proved that it is possible to work with the tax rules to reduce liabilities. Whilst they are not huge reductions, they are an improvement. Royal London suggest that after the employer's NI reimbursement, the tax relief rate can reach 67%, plus monthly NI structuring could allow that number to get closer to 70%.