What was less obvious from the speech was the discreet removal of the 10p starting rate for income tax and the increase in the National Insurance upper earnings limit by £3,900 on top of the normal inflation-linked rise.
The latter change means that people earning between £35,000 and £42,000 will see varying outcomes from the combined changes to income tax and NI. For example, those earning £35,000 will see their income rise by £382.50 in 2008-09 compared with the current tax year. After £35,000, the gains fall rapidly, with those earning £39,800 finding themselves £1.50 a year worse off. However, above £40,000, overall gains begin to rise rapidly again and those earning £41,500 or more will find themselves £297 better off in 2008-09.
The low-paid might feel equally aggrieved. Those earning less than £15,000 will pay more tax and NI. The figures compute as £161.50 a year more tax and NI for a part-timer earning £7,000. However, some of the low-paid may see these losses offset by increases to child benefit and child tax credit.
It is unlikely that many of these low-earners will benefit from good quality financial advice. However, financial advisers do serve middleincome-earners and it is here where advice might be particularly useful.
The reason for the wild variations in the end result for those earning between £35,000 and £41,500 is the change to NI. The 11 per cent band is being expanded and at a faster rate than hitherto, meaning that these people will pay 10 per cent more on this slice than last year. Without the NI change, these people would all be significantly better off, thanks to the reduction in basic-rate income tax from 22 to 20 per cent.
The trick is to keep the benefit of the income tax change but get rid of the loss resulting from the NI change.
The obvious way to achieve this result is through salary sacrifice. Take those in this target group worst hit by the change – those earning £39,800. We have already seen that they are £1.50 worse off each month.
Let us assume our £39,800 earners are paying £400 a month gross to a personal pension out of their own bank account. By giving up £4,800 in salary each year and having their employer pay their pension contribution on their behalf, they could turn themselves from tax losers into tax gainers. Take-home pay would rise in line with a £35,000 earner by £382.50 a year.
Their employer would save 12.8 per cent employer’s NI on the £4,800 sacrificed salary or £614.40 a year. That is nearly a £1,000 a year tax saving between employer and employee. That saving could be used profitably to increase pension contributions. A £1,000 a year contribution for a 40-year-old retiring at 65 would generate an extra pot of over £40,000 in today’s money if the fund grew at a real rate of return of 3.5 per cent net of charges each year.
Paying in a lump sum before April 6 is also beneficial. These people are still basic-rate taxpayers so their pension contributions receive 22 per cent tax relief at the moment but this will fall to 20 per cent on or after April 6. Therefore, the cost of paying in a £10,000 lump sum is £200 a month cheaper now than it will be after these tax changes go through.
John Lawson is head of pensions policy at Standard Life