Personal allowance over £100,000 – 60% income tax trap

If you are a high-income earner, it is important you know how to calculate your personal allowance over £100,000, as it’s a common misconception that the highest rate of effective income tax one can pay is 45%. In fact, due to a feature of UK tax rules, there are two scenarios where individuals are effectively paying up to 60% tax rate on part of their earnings – and it’s affecting more and more people.

The tax implications of earning over £100,000 is just one aspect of your finances we will consider when you seek wealth planning advice from our expert team of independent Wealth Planners. Once you know just how much tax you are paying, we can consider if there are any simple financial planning actions you could take to manage this. It is important to note that ‘income’ is not just your salary but includes all income that is chargeable to income tax, such as earnings from investments, savings income and chargeable events – our independent financial advisers can give you further details.

 

The extra £10,000 salary means that:

• The £10,000 is taxed at 40% – an extra £4,000 tax
• You also lose £5,000 of your personal allowance due to the £1 reduction for every £2 of extra salary over £100,000; this would also now be taxed at 40% – an additional tax of £2,000.

The extra tax would be £6,000 for £10,000 extra earnings – a rate of 60%.

* Please note: different rates apply in Scotland.

How to calculate your personal allowance to avoid the ‘child benefit income tax trap’

If you get child benefits, you could face a ‘high income child benefit tax charge’ of 0.5% for each £100 you earn above £60,000, so the benefit is completely cancelled out by the time you earn £80,000.

For example:

If you have two children and each parent earns less than £60,000 a year, you’d receive approximately £1,820 in child benefits.

However, if one of you received a pay rise of £10,000, you would lose £910 in child benefit, since you incur a ‘high income child benefit tax charge’ of 50%. Because your salary is in the higher rate tax band of 40%, the £10,000 would be taxed at 40% = £4,000. So, your £10,000 pay rise would effectively cost you £4,910 – a tax of 58.2%.  

How to manage the 60% tax rate if you are caught by these income tax traps

Our independent financial planners will work with you to develop a robust wealth management plan which will consider all aspects of your finances, including how much tax you need to pay, including income, capital gains and inheritance tax planning. They will also consider any tax reliefs which are available to you, such as your annual pension contribution and you may be able to make use of unused pension allowances. If you would like a free consultation, contact us.

There are some other actions you can take yourself, to manage the 60% tax rate:

1. Reinstate your personal allowance by contributing more into a pension

The level of income used for assessing how much personal allowance or child benefit you are entitled to is calculated after deducting the gross amount of any pension contributions you have made in that tax year. So, if your earnings were £110,000 pa and you decided to contribute £10,000 (gross) personally into a pension, you would reinstate your personal allowance and you’d be £6,000 better off².

2.    Reduce your cash pay from your employer

This arrangement, known as salary sacrifice, has the advantage of reducing both the income tax you pay and the national insurance you and your employer may pay. Simply reducing your take-home pay through salary sacrifice could work to reinstate your personal allowance or child benefits.

3.    Make gifts to charities under Gift Aid rules

This can have a similar effect. What is more, these could be backdated to the previous year, so long as the donation is made before the tax return for that year is filled.

4.    Make an investment into a Venture Capital Trust (VCT)

Investors can claim 30% income tax relief on VCT investments in the tax year when the funds are invested. The income tax relief is applied against the investors’ income tax liability, with the maximum it can reduce this liability to is nil.

Due to the nature of this type of investment, these can be viewed as high risk, and in order to qualify for this relief, the investment must be held for a minimum of 5 years. There are additional tax benefits to this type of investment, but it is not suitable for everyone. A financial planner will be able to discuss whether or not this option is appropriate.

If you’d like to find out more about income tax and how you can avoid the traps, get in touch with us.

Footnotes:

[2] Income in excess of £100,000 is subject to both higher rate tax of 40% (£4,000) and will also result in a partial loss of the Personal Allowance, £12,570 in the 2024/25 tax year, which is tapered down by £1 for every £2 of income in excess of £100,000 (see scenario A in table below).

A total income of £110,000 (Scenario A) would result in a £5,000 reduction on the Personal Allowance, incurring a further higher rate tax charge at 40% (£2,000).

Therefore, without any pension provision, the £10,000 excess income would be subject to a combined tax charge of £6,000 or an effective tax rate of 60%.

A gross pension contribution of £10,000 (scenario B in table below) would have the effect of reinstating the Personal Allowance in full, whilst providing tax relief at a higher rate, thus saving £6,000 in income tax (see the difference between scenario A and scenario B in table below).

This results in a £5,000 loss of personal allowance, or in tax terms, £2,000 of additional tax due (40% of £5,000).

Therefore, in total this £6,000 tax on the £10,000 would be mitigated by making a gross contribution of £10,000 into a pension (see scenario B in overall table below).