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How to avoid the 60% tax trap?

How to avoid the 60% tax trap?

How can you avoid the 60% income tax trap?

Wednesday 12 December, 2018

If you earn under £100,000 per year, you’ll usually benefit from an annual tax-free personal allowance of £11,850. This means the first £11,850 of your income isn’t taxed.

But once your income goes above £100,000, the tax-free personal allowance tapers away at a rate of £1 for every extra £2 you earn. This means your personal allowance is zero if you earn £123,700 or more.

If you’re currently earning £100,000 and you get a £1,000 pay rise, not only will this cost you £400 in tax on the £1,000, but you’ll lose £500 of your personal allowance. This means an extra £500 is now taxed at 40%, costing you another £200 in tax.

So earning that extra £1,000 costs you £600 in tax. That’s a 60% effective tax rate!

How can tax planning help?

There are several planning options to mitigate this tax trap for example:

Pension contributions can help.

In the above example, making a £1,000 pension contribution can mean your personal allowance is reinstated and you also receive up to 40% tax relief on your contribution. Here’s how:

  • You make an £800 payment
  • The government adds £200
  • As a 40% taxpayer, you can claim back up to a further £200 through your tax return
  • This reduces the effective cost to as little as £600
  • Reducing your income below the £100,000 limit means your personal allowance is reinstated, saving you a further £200 in tax.

Adding £1,000 to your pension effectively costs you just £400, because you avoid the 60% tax trap on that part of your earnings.

Chris Wallace, Managing Director, Visionary Accountants, St Albans said: 'The example shows that there are several options available to mitigate this 60% income tax trap.  If you are worried that you might be affected and want to discuss your own personal situation please get in touch with our St Albans office.  Our accountancy team will review your situation and assist you with tax planning.  Please contact Visionary Accountants, St Albans on 01727 730550 for a free initial consultation.'

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