What is the problem?
Some women in the UK are paying up to 60% tax on part of their income.
Imagine getting a £10,000 bonus and only taking home £3,800 of that bonus. Under the current UK tax rules that’s what happens if you are caught by the deliberate tax squeeze on people earning between £100,00 and £125,140.
What’s going on here and what can you do about it?
What’s going on with the tax system in the UK?
You might imagine a reasonable tax system is set up so that the more money you earn, the more tax you will pay. For the most part in the UK, that is what happens:
The personal allowance means you don’t pay tax on the first £12,570 you earn in the 24/25 tax year.
The percentage tax rate then increases as your earnings increase.
So far, this sounds reasonable. What this table doesn’t show is that for every £2 over £100,000 that you earn, you lose £1 of your personal allowance.
So, for every £100 you earn over £100k that £100 will be taxed at 40%, but you also lose £50 of your 0% allowance, bringing more of your earnings into the 40% higher rate band.
This means that the effective tax rate between £100,000 and £125,140 is around 60%.
Who is affected by the 60% tax rate?
Over time, this is affecting more and more people. In response to the high level of inflation in recent times, wage inflation has also been high. Annual pay growth was running at 6% in January to March 2024. More and more people are getting dragged into paying tax at this punishing rate as a result.
Anyone who earns more than £100,000 is likely to be paying tax at this 60% rate. At Women’s Wealth we can help you to reduce your tax burden however much you are earning. The tactics mentioned here are likely to be most helpful to you if you are earning between £100k and £140k.
So, let’s explore what you can do if you are caught by this tax trap.
Pay into your pension, reduce your taxable income, avoid the 60% trap
Contributing to your pension is a good idea because you get tax relief on the contributions. The contributions reduce your “earnings” for the year from a taxation point of view.
For example, if you earn £115,000 a year and contribute £15,000 to your pension, this £15,000 contribution would reduce your taxable earnings to £100,000. This would have the happy result that you wouldn’t lose any of your personal allowance and therefore wouldn’t be paying tax at the 60% marginal rate.
You are hopefully contributing to a pension already. It’s worth making sure that you are contributing the maximum amount that your employer will match. Increasing the contributions you make to your pension can be a powerful way of reducing your tax bill each year.
Things to watch out for when planning
Your “taxable earnings” according to HMRC will include some of the other benefits you might receive from your employer.
You might receive a car allowance or a London allowance for example. These will often count as part of your total taxable earnings for the year. When you are calculating your taxable earnings, you need to make sure these are added to your salary. Forgetting to do this could lead to you underestimating your taxable earnings, your earnings going over the £100k threshold and you having to pay more tax as a result.
If you have an accountant you might think they are already doing this for you. However, accountants are often more focused on completing tax returns based on what has already happened rather than planning for tax efficiency in the future. So don’t assume they are doing this for you – find a good financial planner who will.
What are the advantages of contributing more to your pension?
Pensions are very tax efficient – not only will you save income tax, if you contribute to your workplace pension directly from your salary you will also pay less in national insurance contributions.
Your pension is likely to be your biggest asset. Yes – even bigger than your house. It is a fund that will build over time and give you more options later in life. It is one of the most important ways to avoid the 60% tax trap.
What are the disadvantages of contributing more to your pension?
The tax advantages come at a cost. The main price you pay in practice is that you won’t be able to access your pension funds until you are 58.
Contributing more to your pension means you can’t spend this money now. Sorry if this is stating the obvious, but it’s good to be clear about the downsides.
“I don’t want to save for my pension – I might not make it to 58.”
This is a classic objection. The tradeoff between your current self who feels very real and your future self who is harder to connect with is a constant battle.
The reality is that you are likely to make it to 58, so try to imagine how grateful your 58-year-old self will be for the options, security and experiences that your pension provides. And even if you don’t make it to 58, your pension will pass on to your loved ones.
Increase pension contributions and avoid the 60% tax trap by being tactical with debt
It is often possible to structure your long-term debt in a way that allows you to contribute more to your pension.
Being “debt free” is an idea many of us aspire to. Paying off the mortgage is seen as a symbol of financial independence and desirable for the feelings of security it will bring.
It’s worth challenging that way of thinking – or at least stopping for a moment to think about which of these will make you wealthier:
- Paying off your mortgage more quickly
- Paying off your mortgage more slowly (and using the savings you make to increase boost your pension contributions)
Not all decisions are purely financial – the emotional benefits of owning your own house might outweigh the financial benefits of increasing your pension contributions. But it’s worth starting with the numbers and then thinking about the emotional side of the decision.
The same kind of thinking can apply to other forms of long-term debt – student loans for example. It might feel good to have finally paid them off, but it might be more profitable to delay repaying them and contribute to your pension pot instead.
We wouldn’t want to encourage you to take out more debt without thinking carefully. But being tactical with debt can help you avoid the 60% tax trap. We can help you explore the different scenarios available to you so that you can make an informed decision about whether to maximise your resources or go debt free.
Other ideas for how to avoid the 60% tax trap
Here are some additional ideas for funding your pension and avoiding the the 60% tax trap:
- Don’t buy a house – if you rent instead of buying could you pay more into your pension?
- Save up in advance – planning for going over that £100k limit could save you tax.
- Use employee share scheme shares to fund your pension.
- Use equity from your buy-to-let to fund pension contributions.
- Get parents or grandparents to contribute to your pension.
Conclusion
The effects of the 60% tax trap can be mitigated through financial planning.
At Women’s Wealth we help our clients to create financial plans that are personalised to their circumstances and aims. These plans help our members to navigate and reduce the impact of tax squeezes like this one. We work with our clients to find strategies that will work for their personal situations.
If you would like to explore how we can help you, book a time to talk to me here.