Are you at risk of falling into the 60% tax trap?
After several months of economic uncertainty and volatility, new chancellor Jeremy Hunt’s autumn statement provided some much-needed stability for the UK economy in November.
One of the measures introduced was a series of tax threshold freezes, designed to increase income for the Treasury over the coming years. Namely:
The Personal Allowance – the amount you can usually earn before you start paying Income Tax – has been frozen at £12,570.
The higher-rate tax (40%) threshold will remain at £50,270.
This will hopefully start to tackle the cost of living crisis and help the government to stabilise the UK economy.
However, thanks to the new measures and a quirk of the taxation system in the UK, approximately 2 million people could face paying 60% tax on a portion of their income by 2028, according to a MoneyAge report.
So, while the income generated may be good for the economy, it could mean that you pay significantly more tax than you anticipated. Read on to learn whether you could fall into this category and how you can reduce your tax liability in the coming years.
The 60% tax trap could affect you if you earn over £100,000 a year
The 60% tax trap is so named because, while there is no marginal Income Tax rate of 60%, the reduction of your Personal Allowance when your income exceeds £100,000 a year means you take home less on a portion of your income.
Your Personal Allowance is reduced by £1 for every £2 of your adjusted net income that is above £100,000. You lose all of your Personal Allowance when your income reaches £125,140.
So, if you earn £100,000 or more, you will not only be paying higher-rate tax (40%), but you will also start to lose the benefit of your Personal Allowance. As a result, the portion of your income between £100,000 and £125,140 is taxed at an effective rate of 60%.
In addition, you’ll likely pay National Insurance contributions (NICs) of 2% on these earnings, meaning that only £38 of every £100 you earn between £100,000 and £125,140 ends up in your pocket.
Inflationary wage increases mean more people will fall into higher tax bands
Even though the new measures might not affect you immediately, as earnings rise over the next few years, more and more people could see their salary exceed £100,000. This is why some have labelled the measures a “stealth tax”, because it relies on inflation increasing wages and bringing more people into the higher tax brackets over the coming years to generate more income in tax for the Treasury.
In fact, MoneyAge has reported research by NFU Mutual showing that by 2028, 2 million workers will be earning over £100,000. This suggests that a further 700,000 people could face the 60% tax trap.
Another notable point from the autumn statement is the planned reduction of the threshold for the additional-rate tax band. At present, you usually pay additional-rate tax on any income above £150,000, but from April 2023, this threshold will be reduced to £125,140. After this date, anyone earning £150,000 or more will pay around an additional £1,200 in tax each tax year.
Salary sacrifice could be a tax-efficient option for you
Salary sacrifice could be a good way to manage the risk of the 60% tax rate if your income exceeds £100,000.
Let’s look at the example of you receiving a £1,000 pay rise, taking your taxable income from £100,000 to £101,000.
If you take the pay increase as salary, you’ll pay 40% (£400) in Income Tax, and your Personal Allowance will reduce by £500 – meaning you’ll pay an additional 40% tax on these earnings (£200). You will effectively lose 60% of the pay rise to tax.
Instead, if you pay that £1,000 into your pension, your taxable income will remain at £100,000 and you won’t be at risk of the 60% tax rate. Plus, you’ll usually receive a 40% top-up on your contribution in the form of tax relief. Depending on your scheme, that £1,000 may also be boosted further with additional employer contributions.
In 2022/23, you can pay a maximum of £40,000 into your pension each year (or 100% of earnings if lower) and still receive tax relief on your contributions.
Get in touch
If you’d like to speak to someone about how to mitigate the impact of the 60% tax trap on your wealth, we can help. Email theteam@fortitudefp.co.uk or call us on 01327 354321.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
This article is for information 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.