Earning over 100k? Tips to avoid the 60% tax trap

What happens when you earn over 100k?

One of the positives of this tiered structure is that most people benefit from a tax-free personal allowance, while higher earners pay a combination of basic rate and higher rate tax, depending on how much they earn. But here comes the wrinkle.

When an individual’s taxable income reaches £100k, their annual personal allowance is gradually cut by £1 for every £2 of additional income.[2] Once their income reaches £125,140, they lose their tax-free personal allowance completely and they start paying the higher rate of tax on their income much sooner. This means that those in the £100k-£125,140 income bracket suddenly finds themselves paying an effective tax rate of 60% on that portion of their earnings.

Impact of a bonus taking your earnings over 100k

How does this work in practice? Let’s say you earn a £100k salary and – good news – you’ve been awarded a £1,000 bonus. Ready for the bad news? Not only will this bonus be taxed at 40% (leaving you with £600), but you also lose £500 from your tax-free personal allowance. To add insult to financial injury, that £500 will also be taxed at 40%, costing you another £200.

When you add it all together, that £1,000 bonus has ended up costing you £600 – and you’ve paid an effective tax rate of 60%. The monetary impact obviously worsens the more you earn over £100,000.

Fortunately, there’s one very straightforward and tax-efficient way to steer clear of the tax trap: make pension contributions. Done effectively, this can help you reclaim your personal tax allowance and receive tax relief on the amount you pay in to your pension.[3]

In fact, it could turn a tricky – and expensive – problem into a highly tax-efficient solution.

The more tax you pay, the harder your investments must work to grow your wealth. Our advisers can provide practical advice to help reduce your tax bill. Get in touch to discuss how we can help you.

How to avoid the 100k tax trap

It’s somewhat ironic that pensions have a reputation as such a traditional and conventional – dare we say it – even boring product. It also doesn’t help that investing in a pension is often unfairly presented as having to make a painful choice between spending the money now or putting it away for retirement.

In reality, pensions can be far more flexible than most people give them credit for. The key is that the government offers really quite generous incentives to encourage people to save for their retirement. Think of it as a government bonus.

The tax relief from the government acts as a ‘top-up’ on the amount you contribute to your pension, and the rates of tax relief are the same as the rates paid on income earned. In other words, basic rate tax-payers receive 20% tax relief on their pension contributions, higher rate tax-payers receive 40% and additional rate taxpayers are in for huge 45% relief.

Here’s the really smart bit: just as having an income that takes you beyond the £100k mark causes a double tax hit, choosing to make pension contributions can have the opposite effect. It lets you claim tax relief on the amount you place into your pension and also lowers your taxable income back to a level where you can regain some of the personal allowance you had just lost.

So, going back to our previous example, if you are earning £100k and receive your £1,000 pay rise but pay the £1,000 into your pension, then not only does your money benefit from higher rate tax relief of 40%, but it also takes your annual income back below the £100k threshold and the dreaded 60% tax zone.

Thanks to the government ‘bonus’ you receive for paying into your pension, the benefits increase the more you earn. For example, if you have earnings of £125,140 (and have therefore lost all your personal allowance), making a pension contribution of £20,112 means the government will apply £5,028 in basic-rate tax relief. They’ll pay this relief straight into your pension, taking your total pension contribution to £25,140.

HMRC will not consider the £25,140 as part of your taxable income, consequently adjusting it back down to £100,000. So, not only have you gained £5,028 in tax relief straight into your pension, but you’ve also saved the same again in higher-rate tax by reclaiming your personal allowance. Further higher-rate tax relief on your pension contribution can then also be reclaimed on your tax return to bring your total benefit up to £15,084 just by making pension contributions.[4] In addition, if your employer offers salary sacrifice as part of your company pension scheme, your contribution will be paid in gross of all income tax.  It could also be gross of national insurance as well if your employer passes on the money they save.

*(40% of the taxable income £25,140 = £10,056) + (40% of the personal allowance £12,570 = £5,028)

Using your pension to take control of your taxes

If all these numbers are starting to make your head spin, don’t worry. Pension planning can be complicated, so you should determine whether making large pension contributions suits your personal circumstances. A financial adviser can provide an assessment of your financial situation and determine a strategy designed specifically for your needs.

It’s also worth remembering that annual pension contributions are capped at £60,000.[5] Anyone with a taxable income of more than £260,000 will also see the annual allowance for their pension tapered – for every £2 of income earned over £260,000, their annual allowance is reduced by £1. A financial adviser can help you to avoid any unexpected tax bills that may result from accidental breaches of the cap.

More importantly, tax and pension rules can change at short notice, so it’s well worth having an adviser on hand who can keep on top of any changes. They can highlight anything that could affect you and help you to respond accordingly.

Expert tax tips for income over 100k

We’ve already covered how pension contributions can be one of the most effective ways to mitigate the 60% tax trap. However, what else can high earners do to keep their tax bill in check? Here are some additional expert tax tips for income over 100k:

1. Make use of gift aid donations

Charitable donations through Gift Aid extend your basic rate tax band, reducing your higher-rate exposure. For example, a £1,000 donation could increase your basic rate band by £1,250.[6] You can find out more about Gift Aid in our article: A guide to Gift Aid : What is it and how might it benefit you? | Saltus

2. Explore salary sacrifice schemes

Salary sacrifice isn’t just for pensions. Some employers allow you to give up part of your salary in exchange for benefits like additional annual leave, cycle-to-work schemes, or electric vehicles. This can reduce your taxable income and potentially bring you back below key thresholds.

3. Utilise ISAs efficiently

While ISAs won’t reduce your taxable income directly, they are a crucial long term tax planning tool. Maximise your annual ISA allowance (£20,000) to grow wealth free of income and capital gains tax, keeping more of your investment growth.[7]

Ultimately, it’s important to ensure that any strategies are appropriate for your wider financial circumstances and goals. If you are unsure, professional financial advice is recommended.

What to do next?

This type of pension planning strategy can be of great benefit to high earners who don’t want to be unfairly penalised by the idiosyncrasies of the UK tax system and recognise the value of paying into their pension while they can. Using this income to make pension contributions is both an instant solution to a difficult problem and a way to significantly increase your retirement pot. That said, managing this alongside high earnings, large investment portfolios, and multiple tax wrappers can be complex. In this scenario, tailored advice, and the right tax tips for income over 100k, can make all the difference.

FAQs

Why is the effective rate 60%?

Because for every £2 you earn over £100,000, you lose £1 of personal allowance. This means that portion is taxed at both 40% and effectively another 20%, creating a 60% marginal rate.

How much personal allowance do I lose if I earn £110,000?

You lose £5,000 of your £12,570 personal allowance.

When do you lose your personal allowance?

You start to lose it once your adjusted net income exceeds £100,000, and it’s completely gone at £125,140.

Does the tax trap affect Child Benefit too?

No. The Child Benefit is affected separately by the High Income Child Benefit Charge, which starts at £50,000.

Does the 100k tax trap affect self-employed and employed people equally?

Yes, it applies to both, based on adjusted net income.

When was the £100k threshold last changed?

It was introduced in 2010 and hasn’t changed since.