Income Tax - Downsides to basic rate reduction
January 2008
On 6 April 2008 the basic rate of income tax will reduce from 22% to 20%. More importantly the starting rate of 10% is abolished from the same date. (In the tax year 2007-2008 the first £2,230 of taxable income is taxed at 10%.)
Three possible adverse affects of these changes are:
1. Low Incomes - if you have a low income you may actually be worse off! The drop in the basic rate to 20% may not fully compensate for the loss of the 10% starting rate band.
2. Pension Contributions (Basic Rate tax payers) - an unwelcome effect of the lower basic rate tax rate is a lowering of total contributions to your pension scheme. At present if you pay £78 into your scheme the Government will top up the contribution with the basic rate tax deducted, £22 - total contributions invested £100. After 5 April 2008 you will need to increase your contributions to £80 per month, tax top up £20, to achieve your £100 total investment. If you do nothing your monthly contributions will decrease at the rate of £2.50 per month, for each £100 presently invested. (2007-2008 net contribution £78 plus tax credit £22 = total contribution £100. 2008-2009 net contribution £78 plus tax credit £19.50 = total contribution £97.50.)
Note for Higher Rate tax payers: If you pay tax at 40% from 6 April 2008 you will be able to claim an additional 20% relief on your pension contributions - prior to 6 April 2008 this was limited to an additional 18%.
3. Gift Aid contributions - the reduction in the basic rate will reduce the total amount received by charities. If you presently pay £78 per year to a charity under the Gift Aid provisions the Government provide a tax rebate of £22 to the charity, total gift £100. After 5 April 2008 the same gift of £78 will create a tax rebate of £19.50. As in the pension example in 2 above, to maintain the combined cash benefit of your gift you will need to increase your contribution to £80
