Getting a pay rise is always a cause for celebration. However, if your salary has ever moved from under to above the £100,000 threshold, you might have been surprised by the sharp increase in the amount of tax you pay.
This isn’t because you have entered into a new tax bracket, as the 45% additional rate only applies to income above £125,140 (for the 2024/25 tax year). Rather, it’s because your Personal Allowance begins to taper once your income exceeds £100,000.
This tapering can create an effective 60% marginal tax rate on your earnings between £100,000 and £125,140. Fortunately, there are strategies to mitigate this trap.
Read on to learn about the 60% tax trap and how pension contributions can help you avoid it.
Your Personal Allowance tapers on your earnings above £100,000
Most people are entitled to an annual tax-free Personal Allowance, meaning no Income Tax is due on earnings up to that amount. In 2024/25, this stands at £12,570.
However, once your annual income exceeds £100,000, your Personal Allowance begins to taper.
For every £2 you earn above this threshold, you lose £1 of your Personal Allowance. This means that by the time your income reaches £125,140, you no longer have a tax-free Personal Allowance.
Without careful planning, you can end up paying a tax rate of 60% on a portion of the income you earn above £100,000
Due to the effects of tapering, you risk facing a 60% tax rate on the income you earn between £100,000 and £125,140.
For example, if you earn £110,000 a year, you exceed the £100,000 threshold by £10,000.
On the excess, you would pay £4,000 in higher-rate Income Tax (40% of £10,000). Additionally, you would lose £5,000 of your Personal Allowance, which would also be taxed at the higher rate, removing another £2,000 from your earnings.
So, in total, £6,000 of the £10,000 you earn above £100,000 would go toward taxes, equating to an effective tax rate of 60% on that portion of your income – and that’s before you pay National Insurance contributions (NICs).
Making additional pension contributions can help you avoid the 60% tax trap
The most common way to avoid the 60% tax trap is to redirect some of your earnings over £100,000 into your pension.
Doing so offers two potential benefits:
- Tax relief – Contributions to your pension are eligible for tax relief. The first 20% of tax relief comes automatically, and if you are a higher- or additional-rate taxpayer you can usually claim further relief through self-assessment.
- Regaining your Personal Allowance – By lowering your adjusted net income, you may regain some or all of the Personal Allowance you would otherwise lose, further reducing your overall tax bill.
For example, let’s say you earn £125,140 annually and pay Income Tax and NICs at the rates set for 2024/25.
Without pension contributions, your entire Personal Allowance would be eliminated due to tapering, and you’d face an effective 60% tax rate on the £25,140 above £100,000.
However, by contributing £25,140 to your pension, you could bring your taxable income back to £100,000. This would not only restore your full Personal Allowance of £12,570 but would also save you 40% in tax on the pension contribution through tax relief.
So, by taking advantage of pension contributions, you can avoid the 60% tax trap, lower your current tax liability, and build a more secure financial future.
It’s important to remember that, for the 2024/25 tax year, most people have an Annual Allowance of £60,000 or 100% of earnings, whichever is lower. Once you exceed this limit, you may face additional tax charges.
Moreover, your Annual Allowance may be reduced if your income exceeds certain thresholds or if you’ve already flexibly accessed your pension.
A financial planner can help you avoid the 60% tax trap
If you’re at risk of falling into the 60% tax trap, a financial planner can help you develop strategies to reduce your taxable income and preserve your wealth.
They can help you make additional pension contributions, ensuring you make the most of your Annual Allowance and any backdating options.
If you are nearing your Annual Allowance, a financial planner can work with you to explore alternative approaches, such as salary sacrifice arrangements to discuss with your employer, to reduce your taxable income while gaining additional benefits.
Get in touch
With the help of a financial planner, you can create a tailored plan to avoid the 60% tax trap while ensuring your finances are sufficient to meet both your short- and long-term goals.
To speak to a financial planner, get in touch.
Please email hello@solusfinancial.co.uk or call us on 01245 984546.
Please note
This article 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 not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
Approved by Best Practice IFA Group Limited on 16/01/2025