Unlock the secret to beating the 60% tax trap

Earning more than £100,000? If so, you might find yourself inadvertently paying as much as 60% tax on part of your earnings. Here’s how you can avoid falling into this tax trap. With the end of the tax year approaching, you might be able to make a difference sooner than you think!

Overview:

Higher-rate taxpayers can unwittingly fall into a 60% tax bracket without realising.
But you can take easy and tax-efficient ways to avoid the 60% tax trap before tax year-end.
A review with your financial adviser can help you can swerve around such tax ‘sinkholes’ – or at least manage them.

If we were to try and sum up the UK tax system, the word ‘complicated’ might feature – with ample opportunity to misinterpret the rules and end up making expensive mistakes.

And these system ‘quirks’ are epitomised by the 60% tax bracket, with higher-rate taxpayers potentially risking paying more tax than they bargained for.

“But wait…” you might be thinking, “a 60% tax band doesn’t appear on HMRC’s listing.”

But trust us, it’s there – if unofficially. It’s created by the tapering of the personal allowance for higher earners, resulting in individuals earning between £100,000 and £125,140 finding themselves paying 60% tax.

Fortunately, not many people are caught up in this particular tax trap, but that’s often why it’s easy to walk into it without realising. It’s therefore useful to have it on your radar, as well as other tax ‘sinkholes’ that can catch you unawares.

Why the 60% tax trap happens

As an earner of £100,000 or more, the rate of Income Tax you pay will be affected by the gradual removal of the £12,570 personal allowance – in other words, the amount of income you can earn each year without paying Income Tax. It’s currently tapered away at a rate of £1 for every £2 you earn above £100,000.

In real terms, this means that for every £100 of income between £100,000 and £125,140, you only get to take £40 home. £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. This amounts to a 60% tax rate.

Once you’re earning £125,140 or more, you don’t get any personal allowance. Not only that, but you’ll also be paying another 2% employee’s National Insurance contribution.

So what can you do to sidestep or mitigate the 60% tax trap?

The power of the pension

We always laud pension contributions as a valuable tool in improving your tax efficiency, and they really come into their own when helping you avoid the spectre of the 60% tax.

One of the quickest and simplest ways to bring your taxable income below the threshold is to pay more into your pension before tax year-end. This is a win-win, since you reduce your tax bill and boost your retirement fund at the same time.

For example, you get a £1,000 pay rise or bonus, which takes your taxable income to £101,000. If you pay that £1,000 into your pension, you won’t enter the 60% tax zone and you’ll get the benefit of a 40% top-up on your contribution, thanks to pension tax relief.

Remember, the pensions annual allowance is the maximum amount that can be paid into a pension each tax year. This includes contributions from yourself, your employer and any third party, as well as tax relief paid to the pension. The current annual allowance is £60,000. However, you’ll only personally get tax relief on contributions up to 100% of your earnings if your earnings are less than the £60,000 annual allowance.

How pension top-ups can cut your tax bill

Yes, the humble pension can help you avoid the “exclusive” 60% group, while still enjoying the benefits of your six-figure salary.

If you’re just over one of the tax bands, topping up your pension before tax year-end on 5th April 2024 can reduce the amount of tax you pay in a number of ways. And any contribution you make reduces your taxable income – so it’s worth paying in as much as you can afford. Don’t forget, subject to conditions, you can also carry forward unused pension allowances from the past three tax years.

A well-timed pension contribution might even help you sidestep the higher rate or additional tax band, so you avoid paying more Income Tax.

You can also nudge your income back down below one of the tax band thresholds if you receive Child Benefit. High-income Child Benefit is a tax charge on families where one partner has a net adjusted income of more than £50,000. This is another charge that uses tapering, with an extra 1% deduction of the amount of Child Benefit for every £100 of income over £50,000.

Taking control of your taxes

This article aims to bring some awareness around the ways that tax allowances can catch you out. The rules can be complicated, and the goalposts often move. But with careful planning, you can continue to enjoy the benefits of your £100,000+ salary without HMRC taking such a large cut. And with the end of the tax year just around the corner, now’s the perfect time to act.

Checking in with your financial adviser on a regular basis (not just before tax year-end) means you can often avoid any tax ‘sinkholes’ or at least manage them.

We’re here to work with you and help you navigate the ever-changing landscape. Talk to us today if you’d like some more advice on beating the 60% tax trap.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

Any tax relief over the basic rate is claimed via your annual tax return.