How does the 60% tax trap occur?
A real world example of the 60% tax trap
Is there anything I can do to reduce or remove this tax burden?
How can Howard Wright help me with the 60% tax trap?
In this article, we are going to discuss income tax and an often overlooked or unknown 60% tax rate. They say that there are only two things guaranteed in life, death and taxes. If you are aware of the income tax system In England and Wales you may know that your income is taxed at a rate of between 0% and 45%. If you are not aware a Google search will take you to the HMRC website which confirms the following tax bandings.
Tax Band Name Tax Band Incomes Tax Rate
Personal Allwoance Up to £12,570 0%
Basic Rate £12,570 – £50,270. 20%
Higher Rate £50,271 – £150,000 40%
Additional Rate £125,140 + 45%
Put simply, you can reduce your income. This doesn’t mean that you earn less or reject income over £100,000. There are ways to reduce your income and still benefit from the funds. The most common of these is to make a pension contribution. Sticking with the example above of a £1,000 bonus, if you are able to make a pension contribution directly from gross pay of £1,000 (known as salary exchange or Salary Sacrifice), your pension receives a full £1,000 contribution and your income for tax purposes reduces to £100,000 keeping you below that effective 60% tax rate.
If you are not able to make a contribution via salary exchange, perhaps because your employer does not offer this, you can make a pension contribution from your net pay (after tax). The pension scheme will claim 20% tax relief directly from HMRC and add it to your pension and you will be able to reclaim the rest of the tax paid via your tax return.
If this is an option that appeals to you, why not talk to one of our chartered financial advisers today. They will be able to work with you to assess if this is something that is suitable for you and make sure you do not exceed your annual allowance with any pension contributions. They will not just assess this in isolation, but will review your overall financial position helping to plan for your future financial objectives and highlight any shortfalls in your provisions.
We have talked about using pensions to reduce income which is where we at Howard Wright can offer advice to clients but there are other salary exchange schemes such as cycle to work which allow you to you give up part of your salary (just like with a pension) to ‘purchase’ a bicycle. Or childcare vouchers which allow you to allocate a portion of your salary in exchange for tax-free daycare vouchers.
Whether you are starting to save for retirement now or, if you started many years ago and want to know if you are on track to achieve your goals, contact Howard Wright today. Not only will we be able to work with you to tailor a strategy to your specific income and capital goals, but we will also be able to ensure you have contingencies in place so that your plan does not fail should you be unable to work due to long term ill health or, if saving as a couple, if one of you passes away.
Although these are the official tax rates, the learning point from today’s blog is to make you aware of an often overlooked or simply unrealised 60% tax rate on your earnings. No that is not a typing error 60% is correct. The reason that it is not published by HMRC is that it is not a “direct tax” but an unofficial effective rate of Income Tax, occurring as a result of the tapering of the personal allowance for higher earners. You may see this in some literature described as the “60% tax trap”
How does this tax trap occur?
A real world example
Is there anything I can do to reduce or remove this tax burden?
Put simply, you can reduce your income. This doesn’t mean that you earn less or reject income over £100,000. There are ways to reduce your income and still benefit from the funds. The most common of these is to make a pension contribution. Sticking with the example above of a £1,000 bonus, if you are able to make a pension contribution directly from gross pay of £1,000 (known as salary exchange or Salary Sacrifice), your pension receives a full £1,000 contribution and your income for tax purposes reduces to £100,000 keeping you below that effective 60% tax rate.
If you are not able to make a contribution via salary exchange, perhaps because your employer does not offer this, you can make a pension contribution from your net pay (after tax). The pension scheme will claim 20% tax relief directly from HMRC and add it to your pension and you will be able to reclaim the rest of the tax paid via your tax return.
If this is an option that appeals to you, why not talk to one of our chartered financial advisers today. They will be able to work with you to assess if this is something that is suitable for you and make sure you do not exceed your annual allowance with any pension contributions. They will not just assess this in isolation, but will review your overall financial position helping to plan for your future financial objectives and highlight any shortfalls in your provisions.
We have talked about using pensions to reduce income which is where we at Howard Wright can offer advice to clients but there are other salary exchange schemes such as cycle to work which allow you to you give up part of your salary (just like with a pension) to ‘purchase’ a bicycle. Or childcare vouchers which allow you to allocate a portion of your salary in exchange for tax-free daycare vouchers.
Whether you are starting to save for retirement now or, if you started many years ago and want to know if you are on track to achieve your goals, contact Howard Wright today. Not only will we be able to work with you to tailor a strategy to your specific income and capital goals, but we will also be able to ensure you have contingencies in place so that your plan does not fail should you be unable to work due to long term ill health or, if saving as a couple, if one of you passes away.
Free Financial Review
If you would like to discuss the 60% tax trap and your retirement planning with Ashley Smith one of our Chartered Financial Planners at Howard Wright, you can call him on 0345 688 4939 or you can fill in our enquiry form below, it only takes 20 seconds to complete. We look forward to hearing from you and seeing how Ashley can help.
Disclaimer
This article contains information from sources believed to be reliable but no guarantee, warranty, or representation, express or implied, is given as to its accuracy or completeness. Howard Wright Ltd does not undertake any obligation to update or revise any future statements. Past performance is not a reliable indicator of future results. Investments can go down as well as up and actual results could differ materially from those anticipated. This article is for information purposes only and has no regard to the specific investment objectives, financial situation or particular needs of any person as such, the information contained in this article is not intended to constitute, and should not be construed as, investment or financial advice. Appropriate personalised advice should be taken before entering into any transactions. No responsibility can be accepted for any loss arising from action taken or refrained from based on this publication. Howard Wright Ltd is Authorised and regulated by the Financial Conduct Authority.