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60% tax trap
Earn between £100,000 and £125,140? Don’t get caught in the tax trap.
What’s the tax trap?
You’re probably aware that higher rate tax is 40%, but did you know that you could be paying an effective rate of 60% tax on some of your income?
If you live in Scotland, tax rates are different, but the tax trap still exists.
See our video and FAQs to find out how to escape the trap.
Let’s take a closer look
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As your income increases above £100,000, your personal tax allowance, or the amount you can earn tax free, reduces. For every £2 of income you earn over £100,000, you lose £1 of personal allowance. And that continues until you pay tax on every penny.
In Olive’s case:
- She earns £110,000.
- This means she loses £5,000 of her personal allowance.
- She therefore not only pays 40% tax on the final £10,000 that she earns.
- She also pays 40% tax on £5,000 of her income she didn’t previously, due to the personal allowance she has lost.
In the example below we compare how much of your income falls into each marginal rate of tax. Look closely at the 40% section and see how this part grows as your income exceeds £100,000. Also note how your personal allowance is reduced.
If Olive puts £10,000 into her pension, she reduces her ‘adjusted net income’ to £100,000. That means she doesn’t lose her personal allowance. She doesn’t fall into the tax trap, and she helps grow her pension, which could give her more money in retirement.
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If you earn £100,000 and get a £1,000 bonus, your bonus takes you above the £100,000 threshold at which you start to lose your personal allowance.
This means you’ll be taxed at an effective rate of 60% for the amount over £100,000. In this scenario, you’ll only get to keep £400 of the additional money as income, Plus, you'll pay National Insurance on the bonus, meaning you’ll see even less in your pay cheque.
Remember, it’s not only a bonus that can take you over the threshold. HMRC counts all sources of income when working out how much income tax you should pay each tax year.
Sources of income, may include, but are not limited to:
- your salary
- other sources such as dividends
- certain types of rental income
- interest.
So, you need to be thinking about the bigger picture.
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If you’re expecting your income to exceed £100,000 this year, it could be worth checking with your employer to see if it’s possible to top up your workplace pension. This can make sense, especially if they offer to contribute too. Contact your employer directly to find out more.
Another option is to consider setting up a separate personal pension.
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It’s easy to open a personal pension with us and start contributing straight away, either on a monthly basis or as a lump sum.
We offer two different pension options, depending on how involved you want to be in selecting investments.
Ready-Made Pension: Our retirement experts manage your pension investments for you, creating a portfolio that’s suitable for your age and expected retirement date.
Self-Invested Personal Pension (SIPP): Gives you the choice of where to invest – putting you in control of your investment strategy and financial future.
Pensions are a long-term investment. What you get back isn’t guaranteed and can go down as well as up. You could get back less than the amount(s) paid in.
By having your pension visible alongside your bank account in our app, it’s easy to keep track of. For more information or to open a pension, visit our pensions page.
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When saving into a personal pension, tax relief plays a significant role. If you're a higher rate taxpayer, it's important to complete a tax return. This means you can claim the tax relief back that you're entitled to.
Please see the GOV.UK full list of who legally must complete a Self-Assessment. This includes anyone earning over £150,000 or who has received any untaxed income, for example from rental property or dividends.
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Pensions are a long-term investment and can only be accessed at retirement age.
Many people underestimate how much they may need for retirement. You can work out what you might need for later life by checking a pension calculator.
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The current income tax bands for England and Wales are as follows:
Income tax bands for England and Wales. Band
Taxable income
Tax rate
Band
Personal allowance
Taxable income
Up to £12,570
Tax rate
0%
Band
Basic rate
Taxable income
£12,571 to £50,270
Tax rate
20%
Band
Higher rate
Taxable income
£50,271 to £125,140
Tax rate
40%
Band
Additional rate
Taxable income
over £125,140
Tax rate
45%
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Tax bands differ in Scotland, but that doesn’t mean the tax trap doesn’t impact you. In fact, it’s even bigger in Scotland as an advanced rate taxpayer pays 45% in income tax. Which means when you lose your personal allowance, you’re paying an effective rate of 67.5% tax on the income you’re earning between £100,000 and £125,140.
The current income tax bands for Scotland are as follows:
Current income tax bands for Scotland. Band
Taxable income
Scottish tax rate
Band
Personal Allowance
Taxable income
Up to £12,570
Scottish tax rate
0%
Band
Starter rate
Taxable income
£12,571 to £14,876
Scottish tax rate
19%
Band
Basic rate
Taxable income
£14,877 to £26,561
Scottish tax rate
20%
Band
Intermediate rate
Taxable income
£25,562 to £43,662
Scottish tax rate
21%
Band
Higher rate
Taxable income
£43,663 to £75,000
Scottish tax rate
42%
Band
Advanced rate
Taxable income
£75,001 to £125,140
Scottish tax rate
45%
Band
Top rate
Taxable income
Over £125,140
Scottish tax rate
48%
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When you reach £125,140 you lose your personal allowance completely and pay tax on every penny you earn.
It’s also the start of the additional-rate tax band, meaning you’d be paying 45% tax (48% in Scotland).
