How you can beat the 60% tax trap

At a glance

• As a higher-rate taxpayer, you might end up paying more tax than you bargained or budgeted for.
• If you’re earning between £100,000 and £125,140, the tapering of the personal allowance means you could end up paying 60% income tax.
• A check in with your financial adviser can help you steer clear of the 60% tax trap this tax year. 

Most people are aware that income tax is charged at 0%, 20%, 40% or 45%, depending on how much you earn. The rates are slightly different in Scotland, but a 60% tax band doesn’t seem to exist – on paper. However, higher-rate taxpayers beware.

If there’s one word to describe the UK tax system, it’s ‘complicated’. Regulations, as we saw in the Autumn Budget, can change frequently and even if you’re more informed than most, it’s easy to misinterpret the rules – and end up walking into a 60% tax trap without realising.

What is the 60% tax trap?

They call it ‘stealth tax’. A 60% rate of income tax isn’t publicised in any HMRC guidelines because it’s an unofficial effective rate of Income Tax. On paper it doesn’t seem to exist.

Yet, because the allowance for higher taxpayers tapers off the more you earn, it can become very real at tax year-end. The result? Those earning between £100,000 and £125,140 can end up paying 60% tax. If you’re in a profession that rewards strong performance with good bonuses, a great year ‘on paper’ can have a nasty sting-in- the-tail at tax year-end.

Why the 60% tax trap happens

Once you’re earning £100,000 or more, the £12,570 personal allowance slowly reduces or tapers off. The personal allowance is the amount of income you can earn each year without paying Income Tax. Currently, the allowance tapers down at a rate of £1 for every £2 you earn above £100,000.

In real terms, this means that for every £100 of income between £100,000 and £125,140, £40 is deducted in Income tax, while another £20 is lost by the tapering of the personal allowance. You will also pay Employee National insurance at 2% on the income. This amounts to a 60% tax rate, plus National insurance. Once you’re earning £125,140 or more, you don’t get any personal allowance at all. It feels like a double jeopardy.

So is it possible to avoid, or mitigate the 60% tax trap?

Beating the 60% tax trap – top up your pension

One of the quickest and simplest ways to bring your taxable income below the threshold is to pay more into your pension before tax year-end. This is a win-win, since you reduce your tax bill and boost your retirement fund at the same time.

Here’s an example. You get a £1,000 pay rise or bonus, which takes your taxable income to £101,000. If you pay that £1,000 into your pension, you won’t enter the 60% tax zone and you’ll get the benefit of a 40% top-up on your contribution, thanks to pension tax relief.

For your information, you can pay a maximum of £60,000 into your pension each year, before you lose government tax relief on your contributions, with carry forward also potentially available.

How pension top-ups can cut your tax bill

If you’re just over one of the tax bands, topping up your pension can reduce the amount of tax you pay in a number of ways. Since any contribution you make reduces your taxable income, it’s worth paying in as much as you can afford.

A well-timed pension contribution might help you stay just below the higher rate tax band, so you avoid paying more income tax. 

You can also massage your income back down below one of the tax band thresholds if you receive Child Benefit. High-income Child Benefit is a tax charge on families where one partner has a net adjusted income of more than £60,000. This is another ‘tapered’ charge, with an extra 1% deducted for every £200 of income over £60,000. Once the higher income earner hits £80,000 take-home, the benefit is withdrawn.

Once again, putting money away in your pension may bring you back down into a lower rate tax band. If you are a higher taxpayer, remember you need to declare – and claim – that tax relief on your pension contributions on your self assessment tax return.

Stay in control of your taxes

Tax rules are complicated, and governments often ‘move the furniture around’ to balance the public finances. Even if the 60% tax trap doesn’t apply to you, it’s worth remembering that taxes and tax regulations in the small print can be easily missed. And as your income rises, so might your tax vulnerability. A minor change might trigger a major effect.

We’re here to work with you and help you navigate the ever-changing landscape. Checking in with your financial adviser on a regular basis means you can often swerve any tax ‘sinkholes’ or at least manage them. The lower your tax bill, the more money you have to enjoy your family time together.

Talk to us today if you’d like some more advice on beating the 60% tax trap. 

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Any tax relief over the basic rate is claimed via your annual tax return.

SJP Approved 18/11/2024