The reduction of the Personal Allowance leads some higher-rate taxpayers to unintentionally pay an effective Income Tax rate of 60%. Luckily, if this applies to you, there may be strategies to lower your tax burden. A report in the Telegraph suggests 1.35 million workers were affected by the 60% tax trap in 2023/24. Collectively, they paid an extra £4.7 billion to the Treasury. Read on to find out if you could unwittingly be paying a higher rate of Income Tax than you expect.
The tax trap affects those earning more than £100,000
You may believe that the highest Income Tax rate is 45%, and officially, that’s accurate. The majority of people pay the standard Income Tax rates. For the 2024/25 tax year, the Income Tax rates and bands are as follows:
Please note, that different Income Tax bands and rates apply in Scotland.
The Personal Allowance decreases by £1 for every £2 earned over £100,000. If your income exceeds £125,140, you lose your Personal Allowance entirely and are taxed on your total income.
For instance, if you earn £101,000, the £1,000 above the threshold would incur £400 in Income Tax at the higher rate. Additionally, you would lose £500 of your Personal Allowance, which means this portion of your income would also be taxed at 40%, amounting to an extra £200.
So, out of the £1,000 earned above the tapered Personal Allowance threshold, you’d retain only £400 – resulting in an effective tax rate of 60%. This has led to the tapering being referred to as a “stealth tax” by the media.
Exacerbating the situation is the fact that the Personal Allowance and Income Tax bands are frozen until 2028.
With these thresholds remaining unchanged, many individuals are likely to see wage increases. Consequently, more people are expected to fall into the 60% tax trap in the upcoming years.
Remember, your salary might not be the only income considered when calculating your Income Tax bill. For instance, you could be liable for tax on interest earned from savings not held in a tax-efficient wrapper.
3 legal ways to avoid falling into the 60% tax trap
If you’re affected by the tapered Personal Allowance, considering how you structure your earnings may help reduce your tax liability. Here are three effective options to consider:
1. Boost your pension contributions
One of the simplest ways to avoid the 60% tax rate if you are affected is to increase your pension contributions.
Your taxable income is calculated after pension contributions are deducted. Therefore, increasing your pension contributions can reduce your adjusted net income, helping you retain the full Personal Allowance or minimize the portion you lose.
Additionally, increasing pension contributions can help you secure a more comfortable retirement. However, remember that you typically cannot access your pension savings until you’re 55 (rising to 57 in 2028).
2. Use a salary sacrifice scheme
If your workplace offers a salary sacrifice scheme, it can be an effective way to reduce your overall tax liability.
Salary sacrifice allows you to exchange a portion of your salary for non-cash benefits from your employer, such as higher pension contributions, childcare vouchers, or a car lease.
By giving up part of your income, you can potentially lower your taxable income below the threshold for the tapered Personal Allowance.
Note that salary sacrifice options vary between employers, so it’s worth checking your employee handbook to see if any options are suitable for you.
3. Make charitable donations from your income
If you want to reduce your Income Tax bill while supporting good causes, consider making charitable donations.
By deducting donations from your salary before tax is calculated, you can manage the amount of Personal Allowance you lose. This strategy not only benefits you by potentially lowering your tax liability but also supports charitable organizations.
Contact us to talk about how to manage your tax bill effectively
There may be additional steps you can take to reduce your overall tax bill. A tailored financial plan will consider your tax liabilities from all sources, including savings and investments, to identify potential strategies for reducing the amount you pay to the taxman.
If you’d like to arrange a meeting to discuss this further, please get in touch.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment that is generally not accessible until age 55 (57 from April 2028). The fund value may fluctuate and can decrease, impacting the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will depend on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in future Finance Acts.
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