It is well known that the UK tax system is complicated at best, with numerous tax pitfalls hidden in plain sight. One of these pitfalls is the ‘hidden 60 per cent tax rate’.
This isn’t an official rate of Income Tax and isn’t mentioned in any of the legislation, but comes from the tapering of the personal allowance, when your income goes over £100,000. It affects anyone earning between £100,000 and £125,140, since the Additional Rate tax band was changed on April 6 2023.
Impact of the new tax rate change
If you earn more than £100,000, your personal allowance of £12,570 is reduced in increments until it reduces to NIL at £125,140. Once it reaches NIL, not only have you lost your tax-free allowance, but you will also be straight into the realms of 45 per cent income tax.
For anyone with income between £100,000 and £125,140, it is this reduction in personal allowance, which saves tax at 20 per cent, combined with the higher rate of 40 per cent tax, which applies to this income, that creates this 60 per cent tax rate.
For example, a higher-rate taxpayer earning £100,000 receives a bonus of £10,000. This £10,000 bonus immediately reduces by £4,000 (the 40 per cent higher rate tax), leaving £6,000.
Then, as the income has breached £100,000, the personal allowance begins to reduce by £1 for every £2 over. The £10,000 bonus now reduces the personal allowance by £5,000 and this reduction pushes income that was taxed at lower rates to be taxed at the higher rate of 40 per cent, being £2,000.
That means that the original £4,000 tax paid, plus the additional £2,000 due because of the personal allowance reduction, gives a total of £6,000 of income tax paid on the £10,000 bonus; an effective rate of 60 per cent.
Impact of frozen Income Tax thresholds
Meanwhile, if either you or your partner earns more than £50,000 a year before tax, you’ll have to pay back some (or all) of your Child Benefit in the form of extra charge known as the High Income Child Benefit Charge.
This charge claws back one per cent of the benefit received for each £100 of income between, £50,000 and £60,000 and is paid through the self-assessment system. If you or your partner’s income exceeds £60,000, the extra tax will cancel out the Child Benefit amount altogether.
Furthermore, given the Chancellor’s decision to freeze the Higher Rate Income Tax Threshold until 2028 more people will find themselves in this position and their income taxed at the higher rate of 40 per cent.
Reducing your taxable income
There are ways you can look to reduce your taxable income, which can be particularly attractive if you are just over one of the thresholds, one of which is by increasing your pension contribution.
Depending on your earnings, this could mean you avoid the 60 per cent pitfall or have no High Income Child Benefit Charge to pay, while also enhancing your retirement benefits.
For advice about different options that may reduce your taxable income, please contact 0808 144 5575 or email help@armstrongwatson.co.uk
