This has been described as the “ultimate stealth tax trap”, as it takes punitive amounts of money, but many don’t realise they’re paying it.
The UK officially has three income tax bands. Basic rate income tax kicks in at earnings above £12,570, and is charged at 20%.
Any earnings above £50,270 are taxed at the higher rate of 40%, while additional rate tax kicks in at 45% on earnings above £125,140 a year.
All three will be frozen at today’s level until 2028, and Chancellor Rachel Reeves might even extend that to 2030 in Wednesday’s Spring Statement. As if that wasn’t enough, National Insurance (NI) is charged on top.
So where does that brutal 60% tax rate come from? That’s a special levy, reserved for those earning between £100,000 and £125,140 a year.
It was introduced by former Labour Chancellor Alistair Darling in April 2010, and reduces the personal allowance by £1 for every £2 earned over £100,000.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said by the time earnings hit £125,140, the personal allowance will have been eroded altogether. “The 60% tax trap is the ultimate stealth tax nibbling away at your income.”
Worse, that £100,000 threshold hasn’t increased in 15 years, dragging more and more people into handing 60% of their income straight to HMRC.
In practice, some people pay a higher marginal rate than 60%, as parents lose access to free childcare benefits while graduates can repay student loans at rates up to 9% of their income a year.
Many won’t have much sympathy given that £100,000 is a lot of money to earn each year. Yet the principle of taking 60% of people’s earnings in income tax is pretty brutal.
Especially given all the other taxes on top, such as NI, VAT, road tax, inheritance tax, capital gains tax, stamp duty and all the rest.
Some higher earners will wonder whether it’s worth the effort when HMRC grabs so much.
It’s also yet another example of how fiscal drag is making people poorer. And with tax bands frozen they’ll lose more every year. Yet there are ways for higher earners to fight back.
Boosting pension contributions can reduce your income for tax purposes and could drag some people back out of the 60% tax trap, Morrissey said.
She takes the case of somebody earning £125,000 per year. Darling’s tax trap will erode their personal allowance from £12,570 to just £70.
In total, the income tax bill would be an eye-watering £42,432, with NI on top.
If that taxpayer could afford a pension contribution of £25,000, this would cut their income down to £100,000, Morrissey said. “They would avoid the 60% tax trap completely as their personal allowance is fully restored.”
This will have slash their total income tax bill to just £27,432. “That’s a whopping £15,000 less than if they hadn’t made the contribution.
The taxpayer wins in the longer term too, by boosting their retirement pot. In an added benefit, they can withdraw 25% of their pension free of tax, under today’s rules at least.
Under the annual allowance, everyone can contribute the equivalent of 100% of their salary to a pension, up to a maximum £60,000 a year.
Morrissey said not everyone can afford to make such a large contribution but even committing smaller amounts can cut tax today and boost pension tomorrow. “A £10,000 contribution for instance, would still save £6,000 income tax for someone in the same scenario.”
If your workplace operates a salary sacrifice scheme, you can also make savings on your NI bill too, Morrissey added.
Just remember you cannot normally withdraw money from your pension until age 55 (rising to 57 in 2028). “So you need to be sure you can do without that income before paying it into the pension.”
