How to navigate the 60% tax trap
Being a top earner in the UK earning £100,000 or more means you could get caught out by the UK’s 60% tax trap and feel the sting of a much higher tax bill then you expected.
What is the 60% tax trap
The 60% tax trap is part of an unofficial rate of Income Tax and is often referred to as ‘stealth tax’. This is not documented with HMRC like the 0%, 20%, 40% or 45% brackets are and often catches many top earners out.
If your income exceeds £100,000, your personal Income Tax allowance is reduced for every additional pound earned, leading to a possible effective tax rate of up to 60%. Even if your usual income is below £100,000 any bonuses can tip the scales and leave you paying far more tax than you first imagined.
The loss of personal allowances could significantly affect your financial plan, especially if you have accounted for more income than you receive. This is why it is important to work with a financial planner who can help you plan.
Losing your personal tax-free allowance
Earning £100,000 or more? You will notice at this point the usual £12,570 tax-free allowance starts tapering off and continues to do so the more you earn over this figure.
Officially, for every £2 earned over £100,000 the allowance reduces by £1. This lost allowance plus the usual 40% higher rate tax creates an effective tax rate of 60% on income earned between £100,000 and £125,140.
How to mitigate the 60% tax trap
Adjusted net income
The loss of your personal allowance is based on your ‘adjusted net income’ for the tax year. This is your total taxable income after deducting the following:
- Trading losses
- Gross donations made to charities through Gift Aid
- Gross pension contributions (before tax relief)
- Pension contributions:
When looking at how to mitigate the 60% tax trap, topping up your pension is the most straight forward answer. Topping up your pension before tax-year end reduces your adjusted net income to allow you to fall below the £100,000 threshold. Meaning you reclaim your personal allowance and simultaneously add further contributions to your retirement funds.
For example, let us say you earn £100,000 and receive a bonus of £10,000. Your bonus would effectively be taxed at 60% due to the loss of your personal allowance as your adjusted net income climbs above £100,000. You can avoid this by contributing that bonus into your pension. This would allow the £10,000 bonus to remain completely untaxed.
Additionally, pension “carry forward” allows you to utilise any unused annual allowances from the previous three tax years.
Here is a quick step by step process on how to avoid the 60% tax trap:
- Identify the trap – look at your earnings, do you earn between £100,000 and £125,140? If so, you are in the 60% tax trap zone.
- Calculate your pension contribution – what contribution do you need to make to your pension to reduce that taxable income? For example, if you earn £110,000 then the ideal solution would be to contribute £10,000 into your pension.
- Check your current year’s allowance – how much of the £60,000 allowance have you already used this year?
- Annual allowance carries forward – if you have already utilised the maximum amount and still have money to contribute to adjust your net income, unused allowances can be carried forwards to help you get there.
Staying in control of your finances
Keeping on top of the ever-changing tax rules and regulations can be difficult. With every Autumn statement there is the possibility of new figures and a shift in thresholds that could catch you out. Our professional in-house tax and estate team can lift this burden and help you keep in control of your finances amidst these changing tax landscapes.
For more insight on how you can reduce your tax exposure, please contact our team.
Important Note
The information contained within this document is subject to the UK regulatory regime and is therefore primarily targeted at consumers based in the UK.
This article is distributed for educational purposes only. This communication does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs.
The opinions stated in this document are those of the author and do not necessarily represent the view of Progeny and should not be relied upon to make a financial decision.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Please note
Tax treatment depends upon individual circumstances and is based on current UK tax legislation, that is subject to change at any time.
