THE 60% TAX TRAP
You’ve just been promoted at work and your salary rises above £100,000 for the first time. Sounds great doesn’t it? But why do you start to receive less in your pocket, pound-for-pound after tax, when you earn over £100,000? It’s the ‘hidden’ 60% marginal tax rate.
Where did this come from?
The marginal tax rate on earnings over £50,000 and under £150,000 is 40%. However, the costly trap exists when an individual earns greater than £100,000. The annual personal allowance, which is the amount each taxpayer can earn at 0% tax, begins to ‘taper’ away when the taxpayer’s earnings are greater than £100,000.
The annual personal allowance, £12,570 for the 2021/22 tax year, reduces by £1 for every £2 earned in excess of £100,000. By the time the tax payer is earning £125,140 the whole of the personal allowance is eliminated. This effectively means the taxpayer is taxed at 60% for their earnings between £100,000 and £125,140. When you add in 2% employee National Insurance, the total taxes amounts to 62%, meaning you take home only 38p for every £1 earned!
Earnings of more than £125,140 are taxed at 40% again, and those who earn more than £150,000 pay 45%.
How to beat the 60% tax trap
One word: PENSION.
This is the most effective way to not only reduce your tax bill but keep money in your investment portfolio for the long-term.
To provide an example, assume your income is £110,000. You could contribute £8,000 into your pension, generating £2,000 in tax relief. This also has the effect of reducing the taxable income to £100,000 and the tax bill by £4,000. Overall you’re £6,000 better off, simply by paying £8,000 into pension. The only consideration is that you cannot access your pension until the age of 55 (57 in 2028).
The other way of reducing your tax bill is to donate to charity. Higher rate taxpayers receive 20% tax relief on the donation given to charity.
They key to these tax savings is to be organised and start planning. The payments to pension and charity must be made in the tax year, not after.
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