Avoiding the 60% Tax Trap
Piotr Arnoldes - Pexels.com
The 60% Tax Trap
If you earn over £100,000 then you will start to lose your Personal Allowance. It is reduced by £1 for every £2 of income over £100,000 so that if you earn more than £125,140 you lose it entirely.
The effective rate of tax for income between £100,000 and £125,140 is 60%. This reflects the fact that you pay 40% on this level of income and also reflects the fact that you have lost some or all of your Personal Allowance and you are paying 40% on that income too.
Making a Pension Contribution
One of the best ways to avoid the 60% income tax trap is to a pay a pension contribution. This effectively provides 60% tax relief or potentially 67% if done via salary sacrifice.
Lets have a look at an example and I’ll keep things simple by looking at an individual earning £125,140 and paying £25,140 into their pension. I’ve also used Income Tax and National Insurance rates applicable now i.e. not pre and post November and I’ve assumed the individual is not subject to Scottish tax rates.
As we can see, a pension contribution of £25,140 only results in a reduction in net income of £10,056. The difference of £15,084 represents an effective tax relief rate of 60% (i.e. £15,084 / £25,140 = 60%).
Salary Sacrifice
It is possible to receive an effective tax relief rate of 67% by arranging for your employer to make a pension contribution by way of salary sacrifice.
We will look at another example where an individual sacrifices £25,140 of salary in return for an employer pension contribution. I’ve also assumed that the employer passes the National Contribution saving to the employee by increasing the pension contribution.
By using Salary Sacrifice, an employer’s pension contribution of £28,609.32 is paid – I’ve assumed the Employer’s NI saving of £3,469.32 is added to the £25,140.00.
The reduction in net income is £9,553.20 which, based on a pension contribution of £28,609.32, represents a difference of £19,056.12. This is an effective tax relief rate of 67% (i.e. £19,056.12 / £28,609.32 = 66.61%).
Retirement Planning
Pensions are a great way to save tax efficiently for retirement. As well as any tax relief on the way in, under current rules, when benefits are taken, up to 25% of the value of the fund can be taken by way of a tax free lump sum.
Contact Us
If you would like to discuss your tax position or if you would like to make a pension contribution, please do get in touch.
Related Posts
