Beware the 60% tax trap

The highest tax-band is 45%. But as Ruth Jackson explains, there is, in fact, a secret band that's substantially higher than that.

Earning a six-figure salary may seem like a reason to pop open the champagne, but you are also joining an exclusive club no-one wants to join the 60% tax club. On the surface, Britain's highest income-tax band is 45%, and that is only paid by those earning over £150,000. But thanks to a quirk in the tax laws, people earning over £100,000 pay an effective 60% income-tax rate on part of their salary.

As soon as you start earning more than £100,000, your personal allowance the amount you can earn before income tax is due tapers away. It decreases at a rate of £1 for every £2 you earn over £100,000. So, once you earn £123,000, you lose your entire £11,500 personal allowance. This means someone earning £123,000 pays £42,500 a year in income tax, as they face the double whammy of the lost personal allowance and, as a result, more income being taxed at 40%. That is £13,800 more tax than someone earning £100,000 and amounts to a 60% income-tax rate on earnings between £100,000 and £123,000 one of the highest income-tax rates in Europe.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

"This tax band is rarely flagged up by the government and political parties, yet it is one of the highest rates of tax we have in this country," Tina Riches, partner at accountancy firm Smith & Williamson, tells The Daily Telegraph. "People don't understand how it works or its effects because it is conveniently described as losing your personal allowance', which is very confusing." An increasing number of people are getting caught in the 60% trap, with the Institute of Fiscal Studies estimating that 800,000 people will pay the 60% rate this year, rising to one million next year if the trend continues.

If you are a member of the 60% club, you can take steps to legally avoid paying that much income tax. The simplest option is to increase your pension contributions. Someone earning £123,000 could make an £18,400 net contribution to their pension and not only benefit from the 40% tax relief on the contribution, but also regain their entire personal allowance. Alternatively, you could look at taking part of your salary in employee benefits to avoid the 60% tax trap. See the belowfor details.

Advertisement - Article continues below

How salary sacrifice works

Salary sacrifice schemes are a way to reduce your taxable income by paying for certain work costs before tax is taken. There are a number of options you can consider, including these three popular ones:

1. Bikes. The Cycle-to-Work scheme allows you to pay for a bike in monthly instalments out of your salary before tax. Someone paying the 60% tax rate could use this salary sacrifice to buy a bike worth £1,000 for just £400.

2. Childcare Vouchers. With this system, you sacrifice part of your salary in return for tax-free vouchers to pay for childcare. There is a limit on how many vouchers you can claim based on your income. Higher-rate taxpayers who signed up to a childcare voucher scheme before April 2011 can claim £243 a month. If you signed up after that your monthly limit is £124. Basic-rate taxpayers can still claim up to £243 a month.

3. Cars. If you lease a company car and it is ultra-low emission you can save around 30% of the cost by doing it via salary sacrifice. Just be very careful what car you choose, as cars with higher emissions may have a tax charge of up to 37%.

In the past, you could also use salary sacrifice to reduce your tax bill and take advantage of perks such as health insurance, mobile-phone bills and school fees. However, the rules regarding how these schemes are treated for tax purposes changed in April. Many of them are now taxed, unless they are protected schemes, which may retain their tax benefits for a set period of time. Check with your employer to see how the tax rules may have changed on any schemes you have already joined.

In the news this week...

Anyone holding their breath for the launch of the first cash Lifetime Individual Savings Account (Lisa) is set to be disappointed, says Laura Suter in The Daily Telegraph. The 0.5% rate from Skipton Building Society is below its standard Isa rate of 0.65% and less than half the best easy-access cash Isa rate, which is 1.05% from Virgin Money. This "meagre" rate is due to a lack of competition. Nationwide Building Society has already said it won't be offering any Lisas due to the 25% exit fee (this is the penalty charged if you withdraw funds for any reason apart from buying a first property, reaching 60, or terminal illness).

Advertisement - Article continues below

The low rate means some savers might even be better off sticking with a help-to-buy Isa until 30 November 2019, after which a Lisa will be the only option. Savers putting the first-year maximum of £3,400 into a Barclays Help-to-Buy Isa would receive £77.29 in interest (before allowing for the government bonus of 25% on any money you contribute). Put the £3,400 into a Skipton Cash Lisa, on the other hand, and you would get just £17.04 interest. However, the higher annual limit of £4,000 for the Lisa means those saving more will still earn a larger bonus.

The surprise election result has sent the pound sliding, and while the "dust has not yet settled", holidaymakers will want to do all they can to limit the effects of a weakened pound, saysEmma Gunn in the Daily Mail. Enter pre-paid currency cards provided you choose the right one. The best rate for euros currently on offer is from Caxton. Its card is free, and carries no extra transaction fees or charges for ATM withdrawals.

Other providers include Moneycorp, Travelex, Revolut and WeSwap. Do check the terms and conditions though. There are some "sneaky" dormancy fees if you don't use your card regularly, which can cost £2-£3 a month. Also, be careful about using them to pay for certain things, such as car hire or hotel bookings, where companies estimate your bill and then ring-fence that amount, as you could be deprived of access to those funds during your trip. Instead, try to use a credit card for the pre-authorisation step and the pre-paid card for the final payment.




What are the best ways of raising more money in tax?

Given that whoever wins next week's election will be going on a massive spending spree, we're going to need to raise at least some of that money throu…
5 Dec 2019
Investment strategy

What are the biggest mistakes investors make when it comes to tax?

The tax implications of an investment are something we rarely consider until after the event. That could prove to be an expensive mistake, says Domini…
27 Nov 2019

How tax has shaped the course of human history

Taxation is as old as civilisation itself. But how much is too much? Dominic Frisby looks at how taxation, war and society have evolved together over …
16 Oct 2019
Personal finance

Pension contributions: what you need to declare on your tax return

Make sure you don't forget to declare your pension contributions in your tax return
28 Jan 2020

Most Popular

House prices

The biggest risk facing the UK housing market right now

For house prices to stagnate or even fall would be healthy for the property market, says John Stepek. But there is a distinct danger that isn't going …
17 Feb 2020
UK Economy

How the BBC can survive the end of the TV licence

The TV licence that funds the BBC is looking way past its sell-by date, says Matthew Lynn. Here's how it could survive without it
16 Feb 2020

Money Minute Monday 17 February: good news ahead for the UK economy?

Today's Money Minute looks to a week in which we get the latest employment and inflation numbers, plus retail figures for January and a slew of eurozo…
17 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019