Earning a six-figure salary is a significant achievement, yet it introduces complex tax considerations.
In the UK, surpassing the £100,000 income threshold triggers a reduction in your Personal Allowance, leading to higher effective tax rates.
This article delves into nine crucial aspects of this tax mechanism and offers strategies to manage its impact!
1. Understanding the Personal Allowance Tapering
At Morrinson Wealth, we often see clients surprised by the Personal Allowance tapering once they cross the £100,000 income threshold.
The tapering process gradually reduces your tax-free allowance, which can lead to a higher effective tax rate. Here’s a closer look at how it works.
What is the Personal Allowance?
The Personal Allowance is the amount of income that’s exempt from tax, set at £12,570 for the 2024 tax year.
This allowance is a tax-free threshold, which generally helps reduce tax liability. However, high earners who cross the £100,000 mark begin to lose this allowance, making more of their income subject to tax.
How Tapering Works
Once your income exceeds £100,000, the allowance begins to taper. For every £2 earned above this threshold, you lose £1 of your Personal Allowance.
For example, an income of £110,000 results in a reduced allowance of £7,570. This “60% tax trap” on income in this range can be a costly surprise.
Complete Allowance Loss Threshold
At £125,140, the Personal Allowance is fully eliminated. This means all income beyond this point is fully taxable, and you no longer benefit from any tax-free allowance.
This threshold makes tax planning essential for high earners aiming to manage their effective tax rate.
2. The 60% Tax Trap Explained
Why is it Considered a “Trap”?
The 60% tax trap is an unofficial term describing the effective 60% tax rate that applies to income between £100,000 and £125,140. This occurs because, for every £2 earned above £100,000, you lose £1 of your Personal Allowance.
As the allowance is reduced, additional income is effectively taxed at a higher rate, making this range unexpectedly costly for high earners.
For many, this “trap” feels like an extra penalty on top of the standard income tax rates.
Calculation Example
To illustrate, imagine you earn £110,000. This amount is £10,000 over the £100,000 threshold, resulting in a £5,000 reduction in your Personal Allowance.
With the standard 40% tax on this income, plus the effective tax from the allowance reduction, you end up paying a rate close to 60% on income within this range. It’s a sharp increase in tax obligations that catches many by surprise.
Implications for High Earners
High-income individuals, especially those in fields like medicine, law, or senior corporate roles, need to be aware of this threshold.
Moving into this bracket without planning can significantly reduce take-home pay, as we’ve seen with clients who were shocked at the limited impact of a pay rise on their actual income.
To manage this, strategies like increased pension contributions or other tax-efficient planning methods can help avoid falling into the 60% trap.
3. Calculating Adjusted Net Income
Components of Adjusted Net Income
At Morrinson Wealth, we often explain Adjusted Net Income as more than just salary. HMRC includes all taxable income—like salary, rental income, and dividends—minus reliefs such as pension contributions and charitable donations.
This figure is essential for determining eligibility for allowances, especially for high earners. We had a client who didn’t realise a large dividend bumped their income and changed their tax picture entirely.
Impact of Pension Contributions and Donations
Using pension contributions and donations can lower Adjusted Net Income effectively.
One of our clients avoided losing their Personal Allowance simply by making a small increase in pension contributions, which saved them thousands. Charitable donations under Gift Aid also help, offering tax relief while supporting favorite causes.
How Adjusted Income Affects Allowances
Adjusted Net Income affects not only your tax bill but also your eligibility for allowances. For instance, crossing £100,000 means tapering of the Personal Allowance, and over £50,000 can trigger the Child Benefit Charge.
We’ve had clients surprised by unexpected tax bills after a bonus or pay rise, showing why managing Adjusted Net Income is crucial to avoid unplanned costs.
4. Impact on Child Benefit and Other Allowances
High Income Child Benefit Charge (HICBC)
The High Income Child Benefit Charge (HICBC) catches many families off guard. Once one parent’s income goes over £50,000, they have to start repaying part of their Child Benefit through extra tax.
And when income hits £60,000 or more, the whole benefit might need to be repaid. For families who rely on this as part of their budget, it can feel like an unexpected financial hit that disrupts their monthly planning.
Other Benefits at Risk
Crossing certain income thresholds doesn’t just impact Child Benefits; other allowances can be affected too. As income goes up, eligibility for things like Personal Allowance or tax credits can start to shrink or disappear altogether.
This can make a pay rise or bonus feel a bit underwhelming once you account for the benefits lost and higher taxes.
Income Thresholds and Adjustments
When your income crosses £100,000, even more changes kick in. The Personal Allowance starts to taper off, which means a higher effective tax rate.
We’ve seen plenty of people surprised when, after a promotion or bonus, their take-home pay didn’t rise as much as they’d hoped. Being mindful of these thresholds and planning for them can really help when it comes to preserving both income and benefits.
5. Strategies to Preserve Your Personal Allowance
Maximise Pension Contributions
Increasing pension contributions is an effective way to reduce taxable income and retain the Personal Allowance.
By adding more to your pension, you can keep your Adjusted Net Income below the £100,000 threshold. At Morrinson Wealth, we’ve seen clients make this adjustment to preserve their full allowance and save on taxes.
Charitable Donations
Making donations through Gift Aid can also reduce taxable income. With Gift Aid, HMRC treats your donation as if you’ve paid tax on it, allowing you to lower your Adjusted Net Income.
This can help keep you under key thresholds, preserving your Personal Allowance while benefiting causes you care about.
Implementing Salary Sacrifice
Salary sacrifice involves exchanging part of your salary for non-cash benefits, like increased pension contributions, which lowers your taxable income.
By doing this, you can maintain your Personal Allowance, effectively reducing the tax burden on higher earnings.
6. Planning for Bonuses and Additional Income
Timing of Bonuses
Timing is crucial when it comes to receiving bonuses, especially if you’re close to the £100,000 threshold. If possible, delaying a bonus until the next tax year can help you avoid pushing your Adjusted Net Income above the limit, preserving your Personal Allowance.
At Morrinson Wealth, we often advise clients to check with their employers to see if there’s flexibility in timing, as even small adjustments can make a significant tax difference.
Alternative Compensation Options
Instead of cash bonuses, exploring non-cash compensation options can help manage tax liabilities. Benefits such as additional annual leave, health insurance, or enhanced pension contributions are worth considering as they do not increase taxable income in the same way as a cash bonus.
Deferred Payments
Deferred payment arrangements are another effective way to stay under the income threshold. If your employer allows, you may be able to defer part of your income to a later tax year, keeping your Adjusted Net Income within limits and preserving allowances.
While not always possible, this can be an ideal solution for those anticipating future income needs but wanting to reduce their immediate tax impact.
7. National Insurance Contributions Considerations
Changes in NIC Rates for High Earners
In the UK, National Insurance Contributions (NICs) are structured to vary with income levels. For the 2024/25 tax year, employees pay NICs at 8% on weekly earnings between £242 and £967, and 2% on earnings above £967.
Employers contribute at a rate of 15% on earnings above £5,000 annually following recent budget changes.
NIC Impact on Overall Tax Burden
NICs significantly affect your net income. For high earners, the 2% rate on income above £967 per week adds to the overall tax burden. Additionally, the increase in employer NICs to 15% may influence salary negotiations and compensation structures, as employers consider these additional costs.
How NICs Relate to Personal Allowance Reduction
While NICs and the Personal Allowance operate independently, both impact your net income. The reduction of the Personal Allowance for incomes over £100,000 increases taxable income, leading to higher income tax liabilities.
Simultaneously, NICs apply to earnings without a cap, meaning higher earnings result in higher NICs. Together, these factors can substantially reduce take-home pay for high earners.
8. The Role of Tax Reliefs and Deductions
Available Reliefs for High Earners
High earners can benefit from tax reliefs like pension contributions, Gift Aid donations, and investment schemes such as the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs).
These options provide tax reliefs that help offset high tax liabilities. We often guide clients at Morrinson Wealth to use these reliefs effectively to maximise their take-home income.
Deductions That Reduce Adjusted Income
Key deductions, like pension contributions and charitable donations, can reduce your Adjusted Net Income. For those close to the £100,000 threshold, increasing pension contributions can lower taxable income enough to retain the full Personal Allowance, saving thousands in taxes.
Seeking Professional Help for Optimising Deductions
Professional advice can be invaluable in navigating complex tax reliefs. We’ve seen clients at Morrinson Wealth benefit from expert guidance, uncovering deductions they weren’t aware of.
A professional can ensure you’re maximising all available reliefs and deductions to keep your tax liabilities as low as possible.
9. Seeking Professional Financial Advice
When to Consult a Tax Adviser
Consulting a tax adviser is beneficial whenever there’s a significant change in your income, such as a new job, bonus, or investment gain.
A timely consultation can help manage your income, protect allowances, and prevent unexpected tax bills. At Morrinson Wealth, we recommend reaching out early to ensure you’re positioned for tax efficiency.
Personalised Financial Strategies
Tailored financial strategies offer high earners the best approach to minimise tax. A personalised strategy can account for specific income sources, family situations, and financial goals. We’ve seen clients save significantly by implementing plans that fit their unique circumstances rather than generic advice.
Legal Implications and Compliance
While optimising tax, staying compliant with HMRC regulations is essential. A professional can ensure your strategies are fully compliant, avoiding penalties while maximising allowances. With the complexity of tax laws, professional guidance can provide peace of mind and clarity in managing your finances effectively.
Final Thoughts From Us
Earning over £100,000 brings about significant tax considerations, particularly concerning the reduction of the Personal Allowance and the resulting higher effective tax rates.
By understanding these mechanisms and implementing strategic financial planning, you can effectively manage and potentially mitigate the impact on your income.
Seeking professional advice is a prudent step to ensure compliance and optimise your financial position.
References
HM Revenue and Customs (2024) Income Tax Rates and Allowances, updated April 2024. This page outlines the current personal allowance and income tax bands for the 2024/25 tax year. Available at: https://www.gov.uk/income-tax-rates (Accessed: 13 November 2024).
HM Revenue and Customs (2024) Income Tax Liabilities Statistics: Tax Year 2021 to 2022 to Tax Year 2024 to 2025, published June 27, 2024. This report includes projections on the number of income taxpayers and their distributions. Available at: https://www.gov.uk/government/statistics/income-tax-liabilities-statistics-tax-year-2021-to-2022-to-tax-year-2024-to-2025/summary-statistics (Accessed: 13 November 2024).
HM Revenue and Customs (2024) Capital Gains Tax Rates and Allowances, updated April 2024. This page provides information on capital gains tax, including allowances and reliefs for 2024/25. Available at: https://www.gov.uk/capital-gains-tax/allowances (Accessed: 13 November 2024).
HM Revenue and Customs (2024) Inheritance Tax: Thresholds and Reliefs, updated July 2024. This page covers inheritance tax thresholds and reliefs applicable for the current tax year. Available at: https://www.gov.uk/inheritance-tax (Accessed: 13 November 2024).
UK (2024) Tax on Dividends, updated April 2024. This page explains the taxation of dividends, including rates and allowances for the current tax year. Available at: https://www.gov.uk/tax-on-dividends (Accessed: 13 November 2024).
Brewin Dolphin (2024) The 60% Tax Trap on Income Over £100,000, published April 2024. This article explains how the tapering of the Personal Allowance results in an effective 60% tax rate for high earners. Available at: https://www.brewin.co.uk/insights/earn-over-100k-beware-the-60-percent-tax-trap (Accessed: 13 November 2024).
GoSelfEmployed (2024) How to Avoid Losing Your Personal Allowance, updated April 2024. This article discusses strategies for reducing taxable income, including pension contributions and charitable donations. Available at: https://goselfemployed.co/personal-allowance-restriction/ (Accessed: 13 November 2024).