Earning a six-figure salary is often something people celebrate, however, not everyone realises that this means you join exclusive “60% tax rate” club.
On the surface, Britain’s highest income bracket is 45% and that is only paid by those earning over £150,000. But, thanks to a quirk in the tax laws, people earning over £100,000 pay an effective 60% income tax rate on part of their salary.
Once you earn over £100,000, your personal allowance is removed; this means for every £2 you earn over £100,000, your personal allowance will decrease by £1. Individuals earning over £123,000 will lose all their personal allowance.
Someone earning over £123,000 will pay £42,500 a year in income tax, as they face the double hit of losing their personal allowance, and as a result, more income is taxed at 40%. This is £13,800 more tax due than someone earning £100,000 and it amounts to a 60% income tax rate on earnings between £100,000 and £123,000.
One of Europe’s highest income taxes
This is one of the highest income taxes in Europe, although it is rarely flagged up by the government and political parties. Many people do not understand how this works and is conveniently described by many as ‘losing your personal allowance’ rather than allowing more income to be taxable.
We wanted to bring this to your attention because an increased number of people are being caught in this 60% trap, with the Institute of Fiscal Studies estimating that 800,000 people will pay the 60% rate this year, rising to one million if this trend continues next year.
Minimising your liability
If you are a member of the 60% club, you can take steps to legally avoid paying that much income tax. The simplest option is to increase your pension contributions. Someone earning £123,000 could make an £18,400 net contribution to their pension and not only benefit from the 40% tax relief on the contribution, but also regain their entire personal allowance.
Alternatively, you could look at taking part of your salary in employee benefits to avoid the 60% tax trap.
How salary sacrifice works?
Salary sacrifice schemes are a way to reduce your taxable income by paying for certain work costs before tax is taken. There are a number of options you can consider, including these three popular ones;
Bikes – the Cycle-To-Work scheme allows you to pay for a bike in monthly instalments out of your salary before tax. Someone paying the 60% tax rate could use this salary sacrifice to buy a bike worth £1,000 for just £400.
Childcare Vouchers – With this system, you sacrifice part of your salary in return for tax-free vouchers to pay for childcare. There is a limit on how many vouchers you can claim based on your income. Higher rate taxpayers who signed up to a childcare voucher scheme before April 2011 can claim £243 a month. If you signed up after that you monthly limit is £124. Basic rate taxpayers can still claim up to £243 a month.
Cars – If you lease a company car and it has ultra-low emissions, you can save around 30% of the cost by doing it via salary sacrifice. Just be very careful what you choose, as cars with higher emissions may have a tax charge of up to 37%.
You could also use salary sacrifice to reduce your tax bill and take advantage of perks such as health insurance, mobile phone bills and school fees. However the rules regarding how these schemes are treated for tax purposes changed in April. Many of them are now taxed, unless they are protected schemes, which may retain their tax benefits for a set period of time. Check with your employer to see how the tax rules may have changed on any schemes you have already joined.