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The tax system here in the UK can be, well, taxing. What should be a case of simple mathematics can often become clouded when things like personal allowances and tapers come into play. And nobody appreciates the complexities quite like a financial advisor trying to explain it all to their clients.

Technically, there is no such thing as paying 60% tax on earnings. The official HMRC income tax brackets are between 0-45% depending on your rate of income. But dig a little deeper and you may find your higher-earning clients are at risk of falling into the 60% Tax Trap.

What is the 60% Tax Trap? 

Although not an officially recognised income tax bracket, the 60% tax trap is a result of the tapering of personal allowances. It affects those clients whose annual earnings are between £100,000 and £125,140.

In simple terms, those with an income of over £100,000 are subject to a decrease of the £12,570 personal allowance – the amount a person can earn before having to pay income tax. And this has knock-on effect when it comes to the sum total that’s lost by higher-earners during the income tax process.

The maths is as follows:

Personal allowance is currently tapered at a rate of £1 for every £2 clients earn above £100,000. This means that, for every £100 of income earned between £100,000 and £125, 140, those higher-earning clients see just £40 of it. That’s because while £40 goes towards paying their income tax, another £20 is swallowed up by the tapering of their personal allowance.

In effect, this results in a 60% rate of income tax for those earning between £100,000 and £125,140. And for those clients with an income of over £125,140, there’s no personal allowance granted at all.

High-earning clients particularly at risk of falling, unknowingly, into the 60% tax trap are those who receive bonuses towards the end of the tax year, potentially taking them above the £100,000 threshold.

How can high-earners avoid the 60% tax trap?

The best way for higher-earning clients to ensure they don’t fall foul of the 60% tax trap is to reduce the amount of taxable income they earn within a single tax year. Increasing pension contributions before tax-year end is an ideal solution. Not only will this take those clients earning over £100,000 below the personal allowance tapering threshold, it also means that instead of losing funds to the income tax process they will be topping up their retirement fund while making the most of their pension tax relief.

The maximum a person can pay into their pension each tax year is £40,000 while still benefitting from tax relief on those contributions.

The takeaway

  • The 60% tax trap is the result of the tapering of personal allowances for those earning over £100,000
  • Clients earning between £100,000 and £125,140 are most at risk of falling into the 60% tax trap
  • High-earners who receive bonuses towards the end of the tax year that take them over the £100,000 threshold are also at risk
  • Increasing pension contributions can help high-earners avoid the 60% tax trap

If you have high-earning clients who fall into the £100,000 – £125,140 income tax bracket, contact CTT Private Client for the best up-to-date information on tax relief and advice.