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

Share this article:

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

20 December 2021

Share this article:

Please fill in your details to arrange a financial review with one of our financial planning or investment experts.

How it works:

  • We will call you back to find out more about your aims and requirements
  • We will arrange a meeting with one of our team at a convenient time, either over the phone, on video, at your home or workplace, or at one of our offices
  • You will be able to ask any questions you have and find out more about managing your wealth with Saltus
  • Your review will be at our cost and there is no obligation to work with us afterwards

Who we work with:

  • Individuals with £250,000 or more in investable assets
  • High earners with £100,000 or more to invest and able to reach £250,000 within five years
Please fill in your details to arrange a discussion with one of our financial planning or investment experts.
Firstname is required
Surname is required
Please enter a valid email address
Phone number is required
Postcode is required

Portfolio size *

We will treat your personal information with respect. By submitting this form, you understand that we will process your information in accordance with our privacy policy, and that you may receive ongoing insights from Saltus by email, phone or post.

How high earners can steer clear of the 60% tax trap

It’s time to shine the spotlight on a wrinkle in the tax code that catches out a lot of unsuspecting people every year. We call it the 60% tax trap.

What do we mean? Well, for those whose earnings go beyond £100,000 in any tax year, some of their income will effectively be taxed at an eye-watering 60%. This should be a particular focus towards the end of the tax year, as individuals often receive bonuses taking them over the £100k threshold at year end. They can be in for a fairly uncomfortable read when they receive their payslip.

Inheritance tax threshold thumbnail
An illustration of a man on roller skates with an ice cream

How high earners can steer clear of the 60% tax trap

It’s time to shine the spotlight on a wrinkle in the tax code that catches out a lot of unsuspecting people every year. We call it the 60% tax trap.

What do we mean? Well, for those whose earnings go beyond £100,000 in any tax year, some of their income will effectively be taxed at an eye-watering 60%. This should be a particular focus towards the end of the tax year, as individuals often receive bonuses taking them over the £100k threshold at year end. They can be in for a fairly uncomfortable read when they receive their payslip.

Understanding income tax rates

So how does the tax trap catch people out? First of all, let’s take a look at the current income tax rates and thresholds for earnings if you live in England, Wales or Northern Ireland.

EarningsRate
£0 to £12,570Personal allowance: no income tax payable
£12,501 to £50,270Basic rate: 20%
£50,001 to £150,000Higher rate: 40%
Over £150,000Additional rate: 45%

One of the positives of this tiered structure is that most people earning an income 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. 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 find themselves paying an tax rate of 60% on that portion of their earnings.

Here’s how easy it is to fall into the 60% tax trap

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.

Find out more in this guide

Did you know that people earning over £100,000 can pay a effective tax rate of 60%?

Download guide

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 also receive tax relief on the amount you pay in to your pension. In fact, it could turn a tricky – and expensive – problem into a highly tax-efficient solution.

Arrange a financial review...

Book a review

Aren’t pensions a bit too inflexible?

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.

How does pension tax relief work when you’ve passed the £100k threshold?

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 of 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. A further £5,028 can also be claimed in higher-rate relief on your tax return.

Watch our webinar

Protecting your most important asset
08 January 2021

In conversation with Jack Munday and Jordan Gillies

Jack Munday
Jordan Gillies

HMRC will not consider the £24,140 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, you’ve also saved the same again in higher rate tax by reclaiming your personal allowance. Further higher-rate tax relief can then be reclaimed on your tax return to bring your total benefit up to £15,084 just by making pension contribution.  In addition, if your employer offers salary sacrifice as part of your company pension scheme, you can claim even more tax relief as your employer may pass on the money they save in national insurance contributions.

Before pension contributionAfter pension contribution
Taxable income£125,140£100,000
Personal pension contribution£0£5,028
Personal tax allowance£0£12,570 (£5,028 tax saving)
Total benefit£0£15,084*

*(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 of 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 £40,000. Anyone with a taxable income of more than £240,000 will also see the annual allowance for their pension tapered – for every £2 of income earned over £240,000, 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.

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 also a way to significantly increase your retirement pot.

In other words, you really can have your cake and eat it too.

Inheritance tax threshold thumbnail

Arrange a financial review...

Book a review

Saltus Financial Planning Ltd is authorised and regulated by the financial conduct authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.

Why Saltus?

Find out more about our award-winning wealth management services…

Finalist

Financial Advisory Firm of the Year

Finalist

Client Relationships Award

Winner

Financial Services, Banking and Insurance Firm of the Year

Finalist

Investment Performance Cautious Portfolios

£2.2bn+

assets under management

18

years working with clients

30+

advisers and investment managers

120+

employees

Discover more

Financial planning

Financial planning can help you reach your goals in life, whether you want to determine when you can retire comfortably, bring organisation to your financial world or pass on your wealth effectively.

Pensions and retirement planning

Deciding when to retire is a challenging decision and can feel like a leap of faith. At Saltus, we gather information on all of your existing assets and then use our technology and expertise to show you exactly how to achieve the retirement you’re after.

Reducing your tax burden

How to structure your wealth and access income should be approached in a sophisticated way. A detailed financial plan may use pensions, ISAs, general investment accounts, offshore bonds and other tax wrappers to ensure you can draw your money in a tax-efficient manner.

Consolidating your wealth

Holding multiple investment accounts and pensions can mean they’re hard to keep track of and administer. We’ll help you overcome this by consolidating your accounts into a single plan so that you can understand your financial position with ease.

Protecting you and your assets

We protect our cars and houses without much thought yet you might be the most valuable asset in your family. Whatever your situation, we can provide advice to ensure you have the right level of insurance in place to keep your finances protected.

Passing on your wealth

Estate planning is more important than just having a Will. We’ll work closely with you to understand how estate planning, which has emotional as well as financial consequences, can impact your overall financial plan.

Significant life events

Significant life events can present great opportunities but also considerable challenges. Whether you are going through a business sale, divorce or are receiving a lump sum, we’ll help build a financial plan to meet your changing lifestyle.

Related blog posts

Get in touch with Saltus…