When it comes to managing your income, understanding the potential tax benefits can significantly impact your overall net cash in hand. In this blog, we'll delve into the strategy of varying your income to retain your basic rate band in alternate years, comparing scenarios to illustrate the potential advantages.
Let's examine two scenarios over a two-year period: earning £100k in year 1 and £150k in year 2 (total £250k) versus earning £125k in both years (total £250k income). The goal is to explore whether alternating income levels can soften the impact of losing the basic rate band and the associated 60% tax trap.
Considering that earning over £100k is more advantageous on salary than on dividends, we'll explore an optimal income mix. The figures are based on majority salary and dividends utilising your basic rate band.
The outcome of our analysis reveals a tangible financial benefit by adopting the strategy of varying income. By taking a £99k salary and £1k dividend in year 1, followed by a £149.5k salary and £0.5k dividend in year 2 (as the tax free dividend decreases next year by £500), you could end up with £3.5k more in your bank compared to a consistent £124k salary and £1k dividend in year 1 and £124.5k salary and £0.5k dividend in year 2. This amounts to a 2% increase in net income over the two-year period, resulting in approximately £155k.
Beyond the immediate financial gain, there are other things to consider:
Childcare Hours: Alternating income levels can help you maintain eligibility for 30 free childcare hours in alternate years.
Mortgage Renewal: Its important to consider when your mortgage is up for renewal as depending on the timing and level of income at that time could impact what you can borrow and the rates.
It's essential to acknowledge that our analysis assumes consistent tax rules across the two years. However, considering the frequent changes in tax regulations and potential changes in government, there is a level of risk associated with this strategy.
Varying your income to retain your basic rate band in alternate years can be a savvy financial strategy. Not only does it offer potential tax savings, but it also provides additional benefits such as childcare hours and improved flexibility in managing financial commitments like mortgage renewals. However, it's crucial to stay informed about evolving tax rules, as they may impact the effectiveness of this approach. Consult with a your accountants and have income planning sessions.
At Gravitate Accounting we offer personal income planning as a service and would happily talk to you about this.
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