If you are earning over £100,000 then you could unknowingly fall into the 60% income tax trap. In the UK, there is a tiered income tax system so the more you earn the higher rate of tax you pay. The good news is that this means most people benefit from the £12,570 tax free allowance. The highest rate of tax they mention is 45%. However, those earning between £100,000 to £125,140 will effectively pay 60% tax because of the tapering of the personal allowance.
Like most tax traps, this can be avoided or at least reduced by taking the correct financial advice. A financial adviser at Four Wealth Management can help you make sure that you only pay the tax that you need to by creating a financial plan for you. Your adviser will look at several solutions for you including increasing pension contributions, salary sacrifice and managing bonuses to help you avoid this tax trap.
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How the 60% trap happens
If you earn over £100,000 then the £12,570 personal allowance will gradually be removed. It is tapered away at a rate of £1 for every £2 you earn over £100,000. This means that for every £100 of income between £100,000 and £125,140, you only get to take £40 home. This is because £40 is deducted in Income Tax, and an additional £20 is lost by the tapering of the personal allowance. This means that if your earnings are within this range then you will effectively be paying 60% tax. Once you earn £125,140 or more, you don’t benefit from any personal allowance.
Below are some simple ways to beat this tax. Tax rules are complex, and it is best to speak to a financial adviser at Four Wealth Management to make sure you are making the right financial decisions for your own circumstances.
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How to use your pension to stop paying 60% income tax
The easiest way to get out of the 60% income tax is to pay more into your pension and therefore bring your take home earnings below £100,000. This means that you are paying less income tax and boosting your pension pot as well as benefiting from pension tax relief.
What tax relief do I get on my pension if I earn over £100,000?
If you earn a £100,000 salary and get a bonus of £1,000 then this bonus will be taxed at 40% (£400) and you will also lose £500 from your tax-free personal allowance which will be taxed at 40% costing another £200. This means that you are only left with £400 of your £1,000 bonus and the situation gets worse the more that you earn.
If you choose to make additional pension contributions then you can get out of this 60% tax trap by reclaiming your personal tax allowance and also receiving tax relief on the amount you pay into your pension. If you were to pay your £1,000 bonus into your pension then you would get an additional 40% tax relief (when claimed through your individual tax return) on top of your £1,000 and your salary would be back at £100,000 meaning you are not in the 60% tax trap.
Pension tax rules are complex
Pension planning and the tax rules around pensions are complex, it is best to speak to a financial adviser before making any decisions about your retirement to make sure that you are making decisions that are correct for your individual circumstances and goals.
Pension rules can change at any time, having a financial adviser will mean that you are aware of any tax rules or changes that will affect your own circumstances.
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The value of a pension may fall as well as rise. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
