Earning a six-figure salary is often something people celebrate, however, not everyone realises that this means you have the dubious pleasure of joining the exclusive “60% tax rate” club.
On the surface, Britain’s highest income bracket is 45% and that is only paid by those earning over £150,000. But, thanks to a quirk in the tax laws, people earning over £100,000 pay an effective 60% income tax rate on part of their income.
Once you earn or your total gross income (to include all taxable sources) exceeds £100,000, your personal allowance is abated and eventually removed; this means for every £2 you earn over £100,000, your personal allowance will decrease by £1. Individuals earning over £125,000 for the current 2019/20 tax year will lose all their personal allowance.
Someone earning non-savings income of £125,000 will pay £42,500 a year in Income Tax, as they face the double hit of losing their personal allowance, and as a result, more income is taxed at 40%. This equates to £15,000 more Income Tax due than someone earning £100,000 and it amounts to a 60% Income Tax rate on earnings between £100,000 and £125,000.
Many people do not understand how this works and is conveniently described by many as ‘losing your personal allowance’ rather than making more income taxable.
We wanted to bring this to your attention because an increased number of people are being caught in this 60% trap.
The other trap is that once your gross income exceeds £100,000 you fulfil one of the criteria for having to register for Self-Assessment and complete and file a personal Tax Return for the relevant tax year, even if all of your Income Tax is collected at source, for example by PAYE, a rule that can often be easily overlooked.
Minimising your liability
If you are a member of the 60% club, you can take steps to legally avoid paying that much Income Tax. One of the simplest options is to increase your pension contributions. Someone earning £125,000 could make an £20,000 net contribution to their pension and not only benefit from the 40% tax relief on the contribution, but also regain their entire personal allowance – the tax saving means the £20,000 net pension contribution has effectively only cost you £10,000, while your pension pot has grown by £25,000 owing to the top-up provided by the government. For ease of illustration, this assumes there are no pension ‘annual’ or ‘lifetime’ allowance issues to consider.
Alternatively, you could look at making donations to charity under gift aid or sacrificing part of your salary to employee benefits to avoid the 60% tax trap.
If your circumstances mean that you are within the 60% club, please do not hesitate to get in touch and we would be pleased to meet with you to review your tax affairs, consider your compliance requirements and look at any tax planning or mitigation strategies that may be available to you.
Find out more about our Income Tax services
Churchgates’s team of registered accountants, tax advisers, solicitors, investment managers and financial planners offer a wealth of experience under one roof in Bury St Edmunds and London. We offer a free no obligation initial meeting to discuss how we might be able to help you. To find out more about our income tax services, click on the link or speak to our specialist team on 01284 701271.
