How you can beat the 60% tax trap

If you’ve just joined the 4% of UK individuals with an income of £100,000 or more, congratulations. It’s a personal achievement that likely took years of hard work, late nights and careful saving and budgeting. And the number of those earning £100,000 or more is growing – in the 2022/23 tax year (the last year that data is available from HMRC) there were 1.35m people in the higher tax bracket – up 16% on the previous year.¹

Since the national average UK salary is £37,500², earning £100,000 should feel more than comfortable. Yet often, it doesn’t. Partly, because the cost of living has soared – but that affects all of us. More importantly, while wages have been steadily rising, personal tax thresholds have remained frozen since April 2021. As a result, more people are tipping into a higher tax band, and finding themselves falling unwittingly into the 60% tax trap.

Earning a six figure sum can feel like being caught between a rock and a hard place.

What is the 60% tax trap?

They call it the ‘stealth tax’. Most people are aware that Income Tax is charged at 0%, 20%, 40% or 45%, depending on the level of your income. The rates are slightly different in Scotland.

However, the allowance for higher taxpayers tapers off as your level of income goes up, those with income between £100,000 and £125,140 can end up paying 60% tax, not 40%. If, for example, you’re in a profession that rewards strong performance with good bonuses, a great year ‘on paper’ can have a nasty sting-in- the-tail at tax year-end.

Why the 60% tax trap happens

It’s the freeze on tax thresholds that is the invisible tripwire that triggers the 60% tax trap. As a basic rate taxpayer, you’re entitled to £12,570 personal allowance, which is the amount of income you can receive each year without paying Income Tax. Once your income is £100,000 or more, the personal allowance slowly reduces or tapers off.

Currently, the allowance tapers down at a rate of £1 for every £2 of income above £100,000. In real terms, this means that for every £100 of income between £100,000 and £125,140, £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. You will also pay Employee National insurance at 2% on the income. This amounts to a 60% tax rate, plus National Insurance. It feels like a double jeopardy.

Once you’re income is £125,140 or more, you are an additional rate taxpayer and lose the allowance completely – and pay 45% tax as a result.

So, is it possible to mitigate the 60% tax trap?

Beating the 60% tax trap – top up your pension

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.

Here's an 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 the pension tax relief for higher rate taxpayers.

The tax benefits of making pension contributions is limited by the annual pension allowance. The current standard annual allowance is £60,000 but it can be lower for high earners. It is however, possible to ‘carry forward’ any unused allowances from the three previous tax years. Tax relief on personal contributions is also limited to a maximum of 100% of earnings in the tax year that you make the contributions.

It’s always a good idea to catch up with your financial adviser if there’s been a change to your financial circumstances, positive or negative – to check on how you can stay tax efficient.

Pension top-ups can cut your tax bill

If you’re just over one of the tax bands, topping up your pension can reduce the amount of tax you pay in a number of ways. Since any contribution you make reduces your taxable income (and gets tax relief) it’s worth paying in as much as you can afford.

A well-timed pension contribution might help you stay just below the higher rate tax band, so you avoid paying more Income Tax. If you are a higher taxpayer, remember you need to declare – and claim – that tax relief on your pension contributions on your self assessment tax return.

You can also massage 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 an adjusted net income of more than £60,000. This is another ‘tapered’ charge, with an extra 1% deducted for every £200 of income over £60,000. Once the higher income earner hits £80,000, bang goes the benefit. If you’re unsure about how to work out your adjusted net income, again – have a word with your financial adviser.

Keeping on top of your taxes

If there’s one word to describe the UK tax system, it’s ‘complicated’. Regulations, as we saw in the Autumn Budget, can change frequently and even if you’re more informed than most, it’s easy to misinterpret the rules – and end up in the 60% tax trap without realising.

Checking in with your financial adviser on a regular basis means you can often swerve any tax ‘sinkholes’ or at least manage them.

Think you might be facing a 60% tax bill? Talk to us today if you’d like some more advice.

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 and are generally dependent on individual circumstances.

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

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