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The hidden 60% tax rate

Mike Wakeford

Most people think the highest rate of income tax in the UK is 45%. But in fact there are two situations where you could be paying much more. 

Inconsistencies in the UK tax system mean that some people pay up to 60% effective tax rates on certain parts of their income. 

If you earn under £100,000 per year, you’ll usually benefit from an annual tax-free personal allowance of £11,850. This means the first £11,850 of your income isn’t taxed. But once your income goes above £100,000, the tax-free personal allowance tapers away at a rate of 50p for every extra £1 you earn. This means your personal allowance is zero if you earn £123,700 or more.

 If you’re currently earning £100,000, and get a £1,000 pay rise, not only will this cost you £400 in tax on the £1,000, but you’ll lose £500 of your personal allowance. This means an extra £500 is now taxed at 40%, costing you another £200 in tax. So earning the extra £1,000 costs you £600 in tax. 

That’s a 60% effective tax rate.

Families where one partner earns between £50,000 and £60,000 a year lose 1% of their child benefit for every £100 earned over £50,000. If you have two children and the higher earner earns £50,000 a year, you’ll receive almost £1,790 per year in child benefit. But if you earn £1,000 extra, this costs you £179 in child benefit, as well as £400 in income tax. That’s £579 in total – an effective tax rate of 57.9%.

So what can you do about this?
Pension contributions can help. In the above example, making a £1,000 pension contribution can mean your personal allowance is reinstated and you also receive up to 40% tax relief on your contribution. Adding £1,000 to your pension effectively costs you just £400, because you avoid the 60% tax trap on that part of your earnings.  However, it is important to get advice from an independent financial adviser before considering any additional pension contributions.

Making Gift Aid donations can also help. Donations to a qualifying charity through Gift Aid can reduce taxable income in the same way as making pension contributions.