The 60% Tax Trap – A Guide for High Earners
Thinking you’ll hit the six-figure salary milestone this year? Then you’ll want to know in advance about the 60% tax rate that could take the edge off your celebrations. You won’t find a 60% tax rate mentioned explicitly on the HMRC website (instead you’ll see the 40% figure). That’s because the additional 20% occurs as a result of the Personal Allowance taper.
Tax is complex, and at Harpur Wealth Management, we regularly work with clients who need advice on how to avoid the 60% tax rate. We understand the issue, therefore, and can offer clear guidance on the strategies used to mitigate the impact of paying excessive tax. In this blog, we’ll take you through how the 60% tax works and what you can do about it.
Understanding the “60% Tax Trap”
If you’re earning between £50,271 to £125,140, you’ll be in the 40% higher rate tax bracket. So, what happens at £100,000 to change the rate of tax you’ll pay so dramatically? It’s a consequence of how the Personal Allowance interacts with higher incomes.
Your Personal Allowance is the amount of income you can earn each year before paying any income tax. For the 2024/25 tax year, it’s £12,570. The allowance begins to decrease once you earn over £100,000.
An Example of the Personal Allowance Taper in Action:
Imagine you’re currently earning £100,000 a year, and you receive a £1,000 pay rise, bringing your annual income to £101,000.
At first glance, you might think this £1,000 will be taxed at the higher rate of 40%, meaning you’d pay £400 in income tax. However, the Personal Allowance taper adds another layer of complexity.
Because your income has now exceeded £100,000, your tax-free Personal Allowance begins to be reduced. Remember, for every £2 you earn above £100,000, your Personal Allowance is reduced by £1. In this case, your income is £1,000 over the threshold, meaning your Personal Allowance is reduced by £500 (half of £1,000).
This reduction in your Personal Allowance means that an additional £500 of your income becomes taxable. This £500 is also taxed at the 40% higher rate, resulting in an extra £200 in income tax.
Here’s a summary:
- Initial tax on the £1,000 pay rise – £400 (40% of £1,000)
- Additional tax due to Personal Allowance reduction – £200 (40% of £500)
- Total tax paid on the £1,000 pay rise – £600
So, from your £1,000 pay rise, you end up paying £600 in tax. This means that your effective tax rate on that extra £1,000 is 60%. This is the essence of the “60% tax trap” – the combination of the higher rate tax and the Personal Allowance taper reduces the net gain from any increase in income over £100,000.
Ways to Navigate the 60% Tax Zone
While everyone wants to know ‘how can I avoid the 60% trap?’ (understandably) we should emphasise that nothing we suggest is about avoiding paying your legitimate share of tax. Having said that, there are ways to manage your taxable income to reduce the impact of the effective 60% tax rate.
Here are some of the approaches we take:
1. Increasing Pension Contributions:
Pension contributions benefit from tax relief, which means that you don’t pay income tax on the money you invest in your pension.
To return to our earlier example: If you were to take that extra £1,000 as salary, you’d only see £400 after the effective 60% tax has been applied. However, if you contribute that £1,000 directly into your pension, you keep the full £1,000.
While you won’t be able to access these funds until you reach 55, the payoff is significant:
- Increased Retirement Savings – You increase your retirement fund by £600 compared to taking the money as taxed income.
- Tax-Free Growth – Your pension investments grow tax-free.
- Tax-Free Lump Sum – You can typically withdraw 25% of your pension fund tax-free when you retire.
2. Salary Sacrifice:
Salary sacrifice is an arrangement you make with your employer to give up part of your gross salary in exchange for non-cash benefits, such as:
- Childcare Vouchers/Directly Contracted Childcare
- Private Medical Insurance
- Company Cars (especially Electric Vehicles)
This approach can also result in National Insurance savings for both parties, making it mutually beneficial.
3. Charitable Giving through Gift Aid:
Donating to charity is another way to reduce your taxable income. Through Gift Aid, charities can reclaim basic rate tax on your donation, effectively increasing its value by 25%.
If you’re a higher or additional rate taxpayer, you can also claim further tax relief through your self-assessment tax return. This means your generosity goes further while also reducing your tax liability.
Please note – Harpur Wealth Management is regulated by the FCA, which does not regulate tax advice. We recommend consulting a qualified tax advisor for specific tax-related guidance.
Harpur Wealth Management – Your Guide Through Tax Complexities
Navigating the 60% tax trap needs careful planning and a thorough understanding of tax-reduction strategies. Here at Harpur Wealth Management, we can be your trusted guide.
As a long-established wealth management company, we have experience of dealing with this issue and will take into account your unique financial and personal circumstances when recommending taxable income strategies.
Here’s how our expertise can help you:
Unveiling Your Tax Advantages – We’ll assess your situation to pinpoint your optimal pension contribution limits. This ensures you’re claiming all the tax relief you’re entitled to, effectively reducing your taxable income and mitigating the 60% tax trap.
Unlocking Every Tax-Saving Opportunity – From exploring a range of pension options to considering additional tax-reduction strategies, we’ll guide you through every step. Our approach ensures you are able to reduce your tax liability effectively.
Concerned about the impact of the 60% tax rate on your income? The Harpur Wealth Management team can help – call us today on 01234 924620
Disclaimer
This article is for information only and must not be considered as financial advice. We always recommend that you seek independent financial advice before making any financial decisions.
The value of your investment can go down as well as up and you may get back less than the amount invested.
‘The Financial Conduct Authority does not regulate taxation advice’
