"As the UK government has increased the amount individuals can contribute to their pensions, the importance of pension tax planning has only become more important for the Scottish higher earner."
- Alexandra Docherty, head of private client tax at Johnston Carmichael
Scottish Finance Minister Shona Robison has introduced a 45% rate of income tax for those earning between £75,000 and £125,140, explaining that "those with the broadest shoulders are [being] asked to contribute a little more".
A further increase of the top rate of from 47% to 48% has also been introduced for those earning over £125,140.
Jon Greer, head of retirement policy at Quilter, discussed how the change could affect pension contributions in the country: "The recent changes to Scotland's income tax structure, specifically with the introduction of a new 45% tax band for individuals earning between £75,000 and £125,140, have wider implications beyond immediate tax liabilities. One key area impacted by these changes is pension contributions, especially for higher earners.
"The increase in the income tax rate for higher earners may lead to a reconsideration of their pension contribution strategies. Since pension contributions can be used as a means to reduce taxable income, individuals in the new 45% bracket might see an increased incentive to contribute more to their pensions, effectively reducing their taxable income and gaining more from the tax relief available on pension contributions.
"However, this strategy's efficacy depends on several factors, including individual financial situations and the specifics of their pension schemes. Clarity on this needs to be given to be swiftly to ensure they can plan effectively. For those in pension schemes operating under the 'relief at source' method, where tax relief is claimed back from HMRC, there could be complexities in claiming the full relief owed, especially for those unfamiliar with detailed tax filings. This could mean that some miss out on increasing their pension contributions while reducing their taxable income.
"The changes also highlight the importance of financial planning and getting advice, especially for those who might not be accustomed to engaging with the complexities of tax returns and pension contributions as they find themselves paying more tax than they were used to."
Steven Cameron, pensions director at Aegon UK, added: “Many income tax payers in Scotland will be counting the costs to them after the Scottish Government announced various income tax rises from next April. While hopes are high that the UK Government will cut income taxes ahead of the next General Election, cuts at UK level will not benefit Scottish residents because income tax rates are ‘devolved’ and set in Holyrood. But one way of reducing the impact is to consider increasing pension contributions.
"One way of reducing the impact is to increase contributions to pensions which benefit from tax relief at the individual’s ‘highest marginal rate’. For those whose earnings fall between £100,000 and £125,140, your pension can be boosted by £,1000 in return for a cut in take-home pay of just £325. Put another way, pension contributions can triple in value as a result of tax relief.
“For those earning between £75,000 and £100,000, their marginal income tax rate is 45% meaning a cut in take-home pay of £550 will boost their pension by £1,000.
“Indeed, anyone who finds they are paying a higher ‘marginal’ income tax rate than before will find pension contributions more tax efficient.
“Some people could find increasing contributions to their pension is an even better deal as some employers ‘match’ employee contributions. If your employer is offering to match you £ for £, you could find your extra personal contribution is worth six times as much when in your pension."
Alexandra Docherty, partner and head of private client tax at Johnston Carmichael, explained the broader implications of the tax hike: “A Scottish resident taxpayer will now be juggling up to 12 different tax rates and 10 tax bands.
“It’s no longer a simple affair to understand how much tax you pay in Scotland on your income and as Scottish taxes continue to diverge from the rest of the UK tax rates and tax bands, there could be a wider economic impact for Scotland in trying to attract talent North of the border. I believe this could particularly impact the financial services sector in Edinburgh, and across Scotland, and these tax changes could see them struggle to compete with the other key financial hubs in London, Bristol and Manchester.
“It had already been noted last year that there was a more marked decline in financial services jobs in Scotland than in the rest of the UK. The further increase to tax rates is unlikely to help to attract that talent to the Capital.
“In addition, these further increases to tax rates will reduce the spending power in the Scottish economy for those facing the brunt of these increases. Someone earning between £100,000 and £125,140 was already experiencing a 63% effective tax rate in Scotland (plus the 2% national insurance burden), due to the loss of the tax-free personal allowance. This will be a 67.5% tax rate by 6 April 2024 (plus 2% national insurance).
“Even without this tax rate increase, some have argued that what the Scottish taxpayer needs instead is a tax reduction. In fact, individuals earning over £28,000 already pay more tax than their UK counterparts. Someone earning £50,000 in Scotland will pay £1,542 more next tax year than their UK counterpart. The tax differential increases as income rises, with someone earning £150,000 in Scotland set to be £5,600 worse off in 2024/25 now this latest tax rate increase has come into play.
“With over 39% of Scotland’s adult population not currently paying any income tax - based on figures published by the Scottish Government in December 2022 - it had been suggested that the focus should potentially have been redirected into ways in which the country can increase the taxpaying workforce, as that in turn would generate more tax revenues, as well as reduce the Scottish Budget deficit.
“Time will tell if the new 45% advanced tax rate for those earning between £75,000 to £125,140, as well as the increased top rate from 47% to 48%, will bridge the financial gap in the budget. The Scottish Government may find that behavioural changes within the group of higher earners, be that by spending less in the local economy, voting with their feet or using other financial levers to dial down income needs in the interim could contribute to the financial gap widening. In particular, as the UK government has increased the amount individuals can contribute to their pensions, the importance of pension tax planning has only become more important for the Scottish higher earner.
“It is clear it was always going to be difficult for the Scottish Government to please everyone with decisions like this, and they’ll be aware further tough decisions lie ahead given the ongoing pressures on public finances.”
