How to Avoid the 60% Tax Trap

How to Avoid the 60% Tax Trap

What is the 60% Tax Trap?

The 60% tax trap is an effective tax rate that impacts individuals in the UK earning between £100,000 and £125,140. This occurs due to the gradual withdrawal of the personal allowance. As income exceeds £100,000, the personal allowance (£12,570 for 2023/24) is reduced by £1 for every £2 of additional income. By the time an individual earns £125,140, the personal allowance is completely eliminated. This leads to an effective marginal tax rate of 60% on income within this band.

How the 60% Tax Trap Works

  • The standard higher rate of tax is 40% on income over £50,270.
  • For every additional £2 earned above £100,000, £1 of personal allowance is lost.
  • This means that effectively, an extra £1 of income incurs not only 40% tax but also an additional 20% due to the lost personal allowance.
  • As a result, the effective tax rate on earnings between £100,000 and £125,140 is 60%.

Strategies to Avoid the 60% Tax Trap

1. Make Pension Contributions

Contributing to a pension scheme reduces your taxable income. By making pension contributions, you can bring your taxable income below the £100,000 threshold and retain your full personal allowance. Additionally, pension contributions benefit from tax relief at your highest marginal rate.

2. Make Charitable Donations

Charitable donations through Gift Aid reduce your taxable income. The government allows taxpayers to extend their basic rate band by the gross amount of their donations, which can help keep taxable income below the threshold.

3. Salary Sacrifice Schemes

Using salary sacrifice arrangements for benefits like pension contributions, cycle-to-work schemes, or additional annual leave can reduce taxable income. This helps to keep earnings below the £100,000 mark and preserve the personal allowance.

4. Utilise Tax-Efficient Investments

Investing in tax-efficient schemes such as Individual Savings Accounts (ISAs) or Venture Capital Trusts (VCTs) can help mitigate the impact of the tax trap, as income and gains from these sources are not included in taxable income.

5. Consider Spousal Income Redistribution

If applicable, transferring income-producing assets to a lower-earning spouse can reduce your taxable income and help avoid the 60% effective tax rate.

6. Defer or Spread Income

If possible, consider deferring income or receiving it in a later tax year where tax rates may be lower. Spreading out bonuses or dividend payments over multiple tax years can help avoid crossing the £100,000 threshold in a single year.

Conclusion

The 60% tax trap can significantly impact high earners in the UK. However, by implementing tax planning strategies such as pension contributions, charitable donations, salary sacrifice, and income redistribution, individuals can reduce their taxable income and mitigate the effects of this tax burden. Seeking professional tax advice can also be beneficial in ensuring the most effective strategy for your financial situation.