What is the 60% high income tax trap?

What is the 60% high income tax trap?

It is well known that the UK tax system is complicated, at best, with numerous tax pitfalls hidden in plain sight. One of these pitfalls is the ‘hidden 60% tax rate’.
If you haven’t heard of the 60% tax rate, don’t worry, you’re not alone!

The 60% tax rate isn’t an official rate of Income Tax, and as a result, isn’t mentioned in any legislation. It comes from the tapering of the personal allowance when your income goes over £100,000. It affect anyone earning between £100,000 and £125,140, since the Additional Rate tax band changed on 6 April 2023.

Most know the income tax rates over the personal allowance in England for employment and self-employment to be 20%, 40% and 45% with the 45% tax rate starting at £150,000 of income. However, this changed on 6 April 2023 and the 45% tax rate now starts at £125,140.

How will I fall into the 60% income tax trap?

If you earn more than £100,000, your personal allowance of £12,570 is reduced in increments until it reduces to NIL at £125,140. Once it reaches NIL, not only have you lost your tax-free allowance, you will now also be straight into the realms of 45% income tax.

For anyone with income between £100,000 and £125,140, it is this reduction in personal allowance, which saves tax at 20%, combined with the higher rate of 40% tax, which applies to this income, that creates this 60% tax rate.

For example, a higher rate taxpayer earning £100,000 receives a bonus of £10,000. This £10,000 bonus immediately reduces by £4,000, the 40% higher rate tax, leaving £6,000. Then, as the income has breached £100,000, the personal allowance begins to reduce by £1 for every £2 over. The £10,000 bonus now reduces the personal allowance by £5,000 and this reduction pushes income that was taxed at lower rates to be taxed at the higher rate of 40%, being £2,000.

That means that the original £4,000 tax paid, plus the additional £2,000 due because of the personal allowance reduction, gives a total of £6,000 of income tax paid on the £10,000 bonus: an effective rate of 60%.

How can I avoid the 60% tax trap?

The good news is that there are simple, yet effective ways to avoid this pitfall, one of which is by making a personal pension contribution.
If your circumstances dictate, contributing to a pension comes with the benefit that, not only could you save income tax at a rate of 60%, but you are also enhancing your retirement benefits at the same time. Assuming it is suitable to do so, making a contribution of your excess income over £100,000, could help side-skirt the pitfall and avoid some or even all of the 60% tax trap.
With that being said, whether you are a higher-rate taxpayer or an additional-rate taxpayer, pension contributions are a simple and effective way to save income tax at your marginal rate.

Can we help you?

My Retirement offers advice to ensure your needs are met as efficiently as possible. If you would like to explore options that may reduce your taxable income, based on your personal circumstances please call 0808 1967625 or email help@myretirement.co.uk.