The 60% Tax Trap: How Earning Over £100k Reduces Your Personal Allowance

In the UK, the official highest income tax rate is the 45% Additional Rate, which applies to earnings over £125,140. However, due to a unique rule in the tax code, individuals earning between £100,000 and £125,140 experience an effective marginal tax rate of 60%. This phenomenon is widely known as the 60% tax trap, and it catches many high-earning employees and newly promoted directors by surprise every year.

How the 60% Tax Trap Works

The tax trap is created by the taper of the Personal Allowance. Under HMRC rules, for every £2 you earn above your Adjusted Net Income of £100,000, you lose £1 of your tax-free Personal Allowance. Because your Personal Allowance is £12,570, it is completely reduced to zero once your income reaches £125,140 (£12,570 multiplied by 2 equals £25,140). This means that in this income band, you pay 40% Higher Rate tax on your earnings, plus an additional 20% tax because your tax-free allowance is being withdrawn, resulting in an effective tax rate of 60% on that £25,140 slice of income.

The Impact on Net Pay and Benefits

To illustrate, if you receive a pay rise or bonus that increases your salary from £100,000 to £110,000, you earn an extra £10,000. Under the tax trap rules, you will pay £6,000 of that £10,000 in Income Tax, leaving you with just £4,000. Additionally, when you include employee National Insurance contributions (currently 2% in this bracket) and potential student loan repayments, your take-home pay on that increase can drop even lower, resulting in a marginal deduction rate of up to 71%.

Legal Strategies to Avoid the 60% Tax Trap

Fortunately, there are standard, fully legal financial planning strategies to reduce your taxable income below the £100,000 threshold:

• Salary Sacrifice Pension Contributions: Contributing your earnings above £100,000 directly into a registered pension scheme reduces your Adjusted Net Income, saving you 60% tax and boosting your retirement fund.
• Charitable Donations: Gift Aid donations to registered charities reduce your taxable income. You can claim back the difference between basic rate and higher rate tax on your self-assessment return.
• Salary Sacrifice Benefits: Exchanging salary for tax-free benefits, such as electric vehicle leasing schemes or cycle-to-work schemes.