If you’re earning between £100,000 and £125,140, the tapering of the personal allowance means you could end up paying 60% tax.
Tax 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.
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.
How It Can Happen
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.
How To Mitigage It
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 To Cut Your Tax
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.
To ensure you are maximising your tax allowances, talk to one of our FCA authorised wealth managers by arranging a Discovery Call [Here]
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