What is the 60% tax trap?

If you’re earning over £100,000, you might find yourself facing the dreaded 60% tax trap. This occurs because your personal allowance (the amount you can earn tax-free) reduces as your income surpasses £100,000. The higher your earnings, the more you lose out, effectively pushing your tax rate up to 60%.

How does the 60% tax trap work?

Basically, everyone in the UK is entitled to an amount of money that’s tax-free. This is called the Personal Tax Allowance and it’s worth £12,570 this tax year. Over this, you pay tax in tranches, from 20% to 45% on your income, otherwise known as your taxable income.

Where does the 60% come from? Well, once you earn over £100,000, you start losing your tax-free Personal Allowance – one pound of allowance per every two pounds over this £100,000 threshold, resulting in an effective 60% tax trap.

If you do the maths, this is an income tax rate of exactly 60% for the income between £100,000 and £125,140. And this doesn’t include National Insurance.

This is the second highest tax rate in all of Europe. There is only one other place that has higher tax: Munkedal, a small region in Sweden with a population of 10,000, which has a staggering marginal tax rate of 70%.

What can you do to reduce your tax rate?

The good news is, there are a few ways to reduce your tax rate and sidestep the 60% tax trap. Here’s what you can do:

Here is our advice:

1. Save more into your pension

Sure – saving money for retirement is the last thing on your mind when you’re in your 20s or even 30s. It does sound like a bad deal: locking money until you’re 55. In reality, it’s one of the best ways to cut your tax bill.

Why should you save into your private pension?

Three reasons:

• You get your tax back on whatever money you save. That 60%? You can get it back
• Your employer usually has to top up your contribution (up to a limit, usually 4-5% of your salary these days)
• And the gains you make, over time, will be tax-free as well. So whatever return you make on your initial investment is completely tax-free when you’re 55

How does the pension tax relief work?

Is your employer using “net pay” for your pension contribution? 

Good news: whatever you save already includes any tax you would have paid. No need to do anything. 

Bad news: it’s quite hard to change how much you save whenever you want to save more – you have to ask your employer whenever you want to save more or less…

Is your employer using “relief at source”? Then how much tax you can get back depends on how much you earn:

• Up to higher rate taxpayers: you can save up to £60,000 into your pension, and get the full tax relief on it (20% automatic relief then an extra 20-25% via your pension provider by filing a Self Assessment tax return)
• Additional rate taxpayers: works the same but you can only save up to £10,000 into your pension
• If your threshold income (income not including your pension contributions) is over £200,000 or your adjusted income (income including pension contributions) is over £240,000: how much you can save decreases gradually

2. Ask for a non-cash bonus instead of a cash one 

This works great if you’re starting out in investment banking or consulting, where usually it’s the bonus that sends you into the 60% tax trap.

By reducing your cash earnings by just a bit, you can push your income below £100,000 – while also getting your bonus. 

For example:

• Private medical insurance (including tests, treatments, etc.)
• Company car (especially if it’s electric)
• Childcare

All of these are tax-free if you get them through a “salary sacrifice” scheme.

3. Invest in startups

This is another great way to save on tax. Although be aware that startups are risky investments and your capital is at risk. The money you invest could go up or down.

This type of investment works similarly to the pension tax relief: you invest in a startup today and you can get the tax back on that amount through a Self Assessment tax return.

There are three startup investment schemes in the UK:

• The Seed Enterprise Investment Scheme (SEIS) gives you 50% back
• The Enterprise Investment Scheme gives you 30% back
• The Venture Capital Trust (VCT) also gives you 30% back

Plus, if the startup that you invest in makes it big, you don’t have to pay any tax on this profit, either. 

How to find startups to invest in if you’re not a professional angel investor:

• Crowdfunding platforms like Seedrs and Crowdcube
• VCT brokers like Hargreaves Landsown or WealthClub

Just remember to file a Self Assessment and declare these investments: if you don’t, not only will you not get your tax back, the gains from the eventual profit (IPO, acquisition…) will not be tax-free either.

The Bottom Line

The 60% tax trap is a sneaky one, but now you know how it works, and more importantly, how to dodge it. Whether it’s through pension contributions or other tax-efficient moves, there are ways to keep more of what you earn. Because let’s be real, no one wants to pay more tax than they have to.