Tax is a complicated business.
And for most taxpayers, many struggle to correctly identify how much they actually pay each year.
Little wonder that so few take full advantage of the many tax reduction options available to them year after year. In fact, according to Revenue estimates, hundreds of millions of Euro goes unclaimed each year.
But back to tax, and how much people pay.
For this example, let’s take a 35-year-old earning €42,000 per year.
According to the most recent Budget changes, someone earning this level of income is in the 20% tax band. In other words, their income is taxed at 20%. Therefore, the natural conclusion is that their income should be 20% less… 20% of €42,000 is €8,400 and so, the take-home pay for this person should be €33,600.
However, their actual income is a lot higher. In this case, they are single with no dependents and their income is €35,062, or €1,462 higher. If they were married and had dependents, their income would be different again.
The reason their after-tax income in not a simple 20% less than their gross income comes down to several factors.
First, they receive several ‘credits’ that reduce their total tax liability. As such, where the State takes with one hand, it gives back with another. So, while the rate of tax is 20% in this case, tax credits reduce the amount of actual tax taken.
There are other factors that also play a role in reducing tax liability. For example, if this 30-something wished to, they could reduce their tax liability further by paying into a pension. In such cases, income tax that would ordinarily be taken for Government coffers are redirected into personal pension accounts. This can be accessed from age 50 onward (restrictions apply) where a significant proportion is tax-free. In other words, the Government actually gives back income tax to save for the future.
Using the same example, this 30-something might wish to put €6,000 into a personal pension. Again, using the assumption that they are taxed at 20% (which they are not), someone might wrongly assume their take-home pay would reduce to €27,600 (€42,000 less 20%, or €8,400 less €6,000 = €27,600).
In fact, thanks to the way tax relief on pension contributions works, their take home pay would be €30,262, a full €2,662 higher.
It can pay to become familiar with how tax relief and tax credits work. They are available to be claimed provided one qualifies. Unfortunately, a lot of people fail to take full advantage of what they can do to reduce their tax bills.
Frank Conway is a Qualified Financial Adviser and Founder of MoneyWhizz
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