Understanding the £100k tax trap

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You might be familiar with the highest income tax band of 45% for additional taxpayers. But did you know that there’s an effective 60% tax rate? Known as the £100k tax trap or 60% tax trap, it happens because the personal allowance gradually reduces once income reaches £100,000. We take a closer look at why it happens and what it means for higher earners.

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The £100k tax trap is a situation in the UK where some high earners find themselves pushed into an effective income tax rate of 60%. This 60% tax rate applies to income over £100k but less than £125,140.

The main income tax rates will be familiar to many, but things start to change when your income exceeds £100,000 a year. At this level, your personal allowance gradually starts to reduce. This is the amount of money you can earn without paying tax, and it’s currently set at £12,570 per year.

For every £2 you earn over £100,000, you lose £1 of your allowance. By the time you’re earning £125,140, there’s no personal allowance left. So why is this known as the £100k tax trap? The term refers to the fact that any income between these amounts is effectively taxed twice:

1. The standard higher tax rate (40%).

2. Another 40% tax on the remaining income after your reduced personal allowance is deducted.

As a result, for every pound you earn between those amounts, you could face an effective rate of 60% tax in the UK.

The 60% income tax trap refers to the income band falling between £100,000 and £125,140 on which taxpayers have to pay an income tax rate of 60%. The following table shows how this 60% tax bracket can be calculated:

With a salary of £101,000, you lose £500 of your allowance. That means £500 of income that was previously tax-free is now taxed at 40%, costing you an extra £200 in tax. And you’ll also pay 40% tax on the £1,000 of income above the threshold, which is £400. Adding up these amounts gives you an effective tax rate of 60% on that portion of income.

A pay rise or bonus at work could push some individuals into this income range, leaving them with less take-home pay than they might have expected. That’s why it’s known as the £100k tax trap. It’s also worth pointing out that, for employees, 2% National Insurance on this income makes the total marginal tax rate 62%, meaning only 38p of every extra £1 earned actually reaches your pocket. So these individuals technically face a 62% tax trap.

Those earning slightly less than £100k will still be able to benefit from their personal allowance, but it only takes a small amount of additional income – perhaps some savings interest or other unexpected income – to push them over that threshold. They would then unwittingly fall victim to the 60% tax trap. 

But this effective 60% tax isn’t listed when you look up the different tax bands, which is why it’s often called a ‘stealth tax’. It’s an extra cost that some taxpayers don’t realise is affecting them. Understanding the £100k tax trap is particularly important for higher earners, because they ultimately pay tax on what would normally be tax-free earnings. This is why some people take proactive measures to try to keep their taxable income below £100,000.

The £100k tax trap affects a wide range of high earners, including:

• Employees earning over £100,000
• Self-employed workers with taxable profits exceeding £100,000
• Umbrella workers. If you’re working through an umbrella company and your salary falls into this range, you’ll face the same tax implications as regular employees

Added to this list is anyone at the top end of the higher-rate tax bracket, as they could be given a pay rise, bonus, or any extra income that could push them into the £100k tax trap.

Because the tax trap only applies to income over £100k, if you’re worried about falling into the tax trap when your income reaches £100k, there are a few different options you might consider.

One option often suggested by experts is to redirect any extra income to your pension. Say your usual salary is £100,000 and you receive a £15,000 bonus before the end of the tax year. By putting that straight into your pension, your adjusted income stays below £100,000. The full personal allowance is then restored. Plus, you get pension tax relief of 40% on your contribution.

There are a few different ways of doing this, the most common being salary sacrifice. This is where any bonus you receive from your employer is paid directly into your pension before tax is applied. Another option is to make a personal contribution from your post-tax income, but you would have to make a claim with HMRC later.

This can help in two ways: not only do you save additional tax by avoiding the 60% tax bracket on that extra income, you’re also growing your pension pot at the same time.

Keep in mind that there are maximum pension contribution limits to still receive tax relief. For most people, the limit is the lower of 100% of your salary or £60,000. If you exceed the annual limit, you could face a tax charge that reduces the relief on the extra amount.

While pension contributions are generally considered the most effective way to redirect any extra income, making donations to charity is another option. Charitable donations eligible for Gift Aid can reduce your taxable income.

Alternatively, you could try to receive bonus payments in stages or delay them until the following tax year to avoid pushing yourself into the £100k tax trap. For expert guidance, you might get in touch with a qualified financial adviser.

While savings interest counts towards your taxable income, the personal savings allowance means that higher-rate taxpayers won’t have to pay tax as long as the interest they earn is less than £500.

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