“Surprise” Tax Hike: How Earning Over £100,000 Could Cost You More Than Expected

For many, earning a six-figure salary may signify reaching a peak in financial success. However, what they might not realize is that crossing the £100,000 threshold could unexpectedly land them in a 60% tax bracket due to certain UK tax rules. Understanding these regulations and the steps one can take to mitigate their impact is crucial for high earners looking to efficiently manage their finances, an article in the Express says.

The £100,000 Threshold: What Does It Mean for Your Taxes?

In the UK, the personal allowance is the amount you can earn tax-free each year, currently set at £12,570. However, this allowance starts to diminish for individuals earning over £100,000. Specifically, for every £2 earned over this threshold, the personal allowance is reduced by £1. This reduction can result in an effective 60% tax rate on earnings between £100,000 and £125,140, as the lost allowance increases the taxable income.

For example, if you earn £110,000 in the current tax year, your personal allowance decreases from £12,570 to £7,570. This reduction means an additional £5,000 of your income is taxed at the 40% rate, leading to a higher effective tax rate.

The situation escalates when an individual’s income reaches £125,140, at which point the personal allowance is completely phased out.

Salary Sacrifice: A Solution to the Tax Dilemma

Sarah Hollowell, Tax and Trustee Services Director at Killik & Co, highlights salary sacrifice as one viable strategy to counteract this effective 60% tax rate. By requesting your employer to reduce your salary to just below the £100,000 mark and redirect the excess into your pension, you effectively lower your taxable salary. This not only provides income tax savings but also reduces national insurance contributions.

However, this option isn’t universally available. If you’re self-employed or your employer doesn’t offer a salary sacrifice scheme, making personal pension contributions equivalent to the amount over £100,000 can be an alternative.

Contributing to a personal pension garners tax relief. When you make a contribution, the government provides basic rate tax relief, meaning to decrease your taxable income by £10,000, you’d need to contribute only £8,000 from your pocket. The remaining relief is claimed through self-assessment. These contributions, akin to those made under a salary sacrifice arrangement, are considered employer contributions, keeping your taxable income below the critical threshold and your personal allowance intact.

Other Income and Tax Strategies

It’s essential to remember that it’s not just salary pushing you over the threshold; all taxable income, including profits from a buy-to-let property or earnings on savings and investments, counts towards it.

In a time of rising interest rates and reduced dividend allowances, more people might face tax liabilities on their investment income. Utilizing your annual ISA allowance can be an efficient method to reduce the tax hit on these earnings.

Moreover, for married couples where one partner earns significantly more, transferring investments to the lower earner can be beneficial. This strategy utilises not only the lower tax rates of the receiving spouse but also helps in retaining the personal allowance for the higher earner.

Navigating the Tax Maze

The intricacy of tax rules can often lead to unexpected financial challenges, especially when salary increases or bonuses push earnings over the £100,000 mark. Planning and using strategies like salary sacrifice or pension contributions can help mitigate the effects of the personal allowance taper.

Ensuring you understand these thresholds, and taking proactive steps to manage your income and investments, is key to avoiding a “surprise” at tax time. If in doubt, consulting with a tax advisor or financial planner can provide tailored strategies that suit your personal financial circumstances.