How you can beat the 60% tax trap

12 January 2024

At a glance

Ever heard of anyone paying 60% tax? Chances are not, since, according to HMRC, 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.

However, higher-rate taxpayers beware.

If there’s one word to describe the UK tax system, it’s ‘complicated’. Regulations can change frequently and even if you’re more informed than most of us are, it’s easy to misinterpret the rules, and end up make some expensive mistakes. Especially if you walk into a 60% tax trap without realising.

What is the 60% tax trap?

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 appear to exist. Yet, because the allowance for higher taxpayers tapers off the more you earn, it can suddenly become very real at tax year-end.

The result? Those earning between £100,000 and £125,140 can end up paying 60% tax.

Even if it doesn’t apply to you, it’s worth remembering that taxes can appear almost by stealth. And as your income rises, so do your chances of getting caught in the trap. These so-called tax ‘sinkholes’ can appear overnight – and a minor change might have a major effect on your tax liability.

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, you only get to take £40 home – £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. This amounts to a 60% tax rate. Once you’re earning £125,140 or more, you don’t get any personal allowance at all. Not only that, but you’ll also be paying another 2% employee’s National Insurance contribution.

So what can you do to sidestep 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.

Just FYI, you can pay a maximum of £60,000 into your pension each year, and still enjoy tax relief on your contributions.

How pension top-ups can cut your tax bill

If you’re just over one of the tax bands, topping up your pension before tax year-end on 5 April can reduce the amount of tax you pay in a number of ways. And any contribution you make reduces your taxable income – so it’s worth paying in as much as you can afford.

A well-timed pension contribution might help you sidestep the higher rate or additional 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 £50,000. This is another charge that uses tapering, with an extra 1% deduction of the amount of Child Benefit for every £100 of income over £50,000.

Once again, putting money away in your pension may bring you back down into a lower rate tax band.

Taking control of your taxes

Tax rules are complicated, and the goalposts often move. Checking in with your financial adviser on a regular basis (not just before tax year-end!) means you can often swerve around any tax ‘sinkholes’ or at least manage them.

Financial advice helps you and your family feel confident and in control of both your money and your taxes. The lower your tax bill, the more money you have to enjoy your family time together.

At St. James’s Place, we’re here to work with you and help you navigate the ever-changing landscape.

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: 28/12/2023

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