How to avoid the 60 per cent income tax trap
As more taxpayers have part of their earnings taxed at an effective rate of 60 per cent, financial advisers are working to help clients avoid the so-called income ‘tax trap’.
A freedom of information request submitted by Bowmore Financial Planning to HM Revenue & Customs revealed that in 2023-24, 634,000 taxpayers earning between £100,000 and £125,000 were hit with an effective 60 per cent tax rate on a slice of their earnings.
The finding was first reported by the Financial Times.
Taxpayers have a tax-free personal allowance of £12,570.
However, the tax trap occurs because once someone earns £100,000, each extra pound of income triggers a loss of 50p of their tax-free personal allowance.
Once income reaches £125,140, the personal allowance is eliminated, leading to an effective tax rate of 60 per cent on earnings between £100,000 and £125,140.
The number of taxpayers falling into this tax trap has nearly doubled in the past five years.
Financial advisers are fielding queries from clients on how to respond to this quirk in the tax system.
“People are taking pay rises, getting bonuses, and then suddenly they’ve gone from 40 per cent tax to 60 per cent tax,” says Sam Binstead, chartered financial planner and investment director at Chilvester Financial.
“In an ideal world, you’d bring your income back down below £100,000, but that’s not always feasible when you need to pay the mortgage and put food on the table.”
Contribute to your pension
Without proper planning, you could end up paying far more tax than necessary.
But there are legal ways to reduce your taxable income and minimise the impact of this trap.
“The best way for most people is contributing to their pension,” says Frederick McCarthy, chartered financial planner at Augustine Financial Planning. This can be done via personal contributions and employer contributions.
Savers can also reach a salary sacrifice arrangement with their employer, under which they would receive lower income in exchange for additional pension contributions.
“They get to boost their pot for later, get good tax relief, and they get their personal allowance back and don’t pay that 60 per cent tax trap”, McCarthy says.
Salary sacrifice arrangements can also offer other non-cash benefits, such as support for buying electric vehicles. Savers can also donate to charity and use Gift Aid, which lowers their taxable income.
Arthur Hill, chartered financial planner at Citygate Financial Planning, advises employees to keep an eye on their bonuses and when they are due.
“That can push people over the tax band unwittingly,” he says, adding that it can be worth sacrificing bonuses directly into pensions instead.
How to navigate the 60 per cent tax trap
City PM has teamed up with TaxScouts to help readers understand the world of tax.*
A consultation with a TaxScouts’ accountant can help you navigate the 60 per cent tax trap and implement strategies to reduce your taxable income, including:
- Increasing pension contributions to bring your income below the £100k threshold, reducing the loss of personal allowance.
- Salary sacrifice schemes for tax-efficient benefits like childcare vouchers or electric vehicles.
- Structuring your bonuses or dividends in a way that maximises tax efficiency.
For those who need to file a tax return, TaxScouts ensures your income is reported correctly and that you claim all available tax reliefs to reduce your liability.
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