A leading Aberdeen wealth expert is warning against a 60% tax 'trap' that an increasing number of people are falling into across the North-east.
The number of those earning £100,000 or more is growing – in the last full year of data released by HMRC, there were 1.3million people in the higher tax bracket across the UK – up 16% on the previous year.
But while wages have been steadily rising, personal tax thresholds have remained frozen, and as a result more people are tipping into a higher tax band, and finding themselves falling unwittingly into the 60% tax trap.
What is the 60% tax trap?
In Scotland, Income Tax is charged at 0%, 19%, 20%, 21%, 42%, 45% or 48%, depending on the level of your income.
However, the allowance for higher taxpayers tapers off as your level of income goes up, those with income between £100,000 and £125,140 can end up paying 60% tax.
If, for example, you’re in a profession that rewards strong performance with good bonuses, a great year ‘on paper’ can have a nasty sting-in-the-tail at tax year-end.
Why the 60% tax trap happens
Gray Walker, founder of Gary Walker Wealth Management, said: "It’s the freeze on tax thresholds that is the invisible tripwire that triggers the 60% tax trap.
"As a basic rate taxpayer, you’re entitled to £12,570 personal allowance, which is the amount of income you can receive each year without paying Income Tax. Once your income is £100,000 or more, the personal allowance slowly reduces or tapers off.
"Currently, the allowance tapers down at a rate of £1 for every £2 of income above £100,000. In real terms, this means that for every £100 of income between £100,000 and £125,140, £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. You will also pay Employee National insurance at on the income. This amounts to a 60% tax rate, plus National Insurance. It feels like a double jeopardy."
Once your income is £125,140 or more, you are an additional rate taxpayer and lose the allowance completely
Beating the 60% tax trap – top up your pension
Gary says one of the quickest and simplest ways to bring your taxable income below the threshold is to pay more into your pension before tax year-end. This is a win-win, since you reduce your tax bill and boost your retirement fund at the same time.
He added: "Here's an example. You get a £1,000 pay rise or bonus, which takes your taxable income to £101,000. If you pay that £1,000 into your pension, you won’t enter the 60% tax zone and you’ll get the benefit of a 40% top-up on your contribution, thanks to the pension tax relief for higher rate taxpayers.
"The tax benefits of making pension contributions is limited by the annual pension allowance. The current standard annual allowance is £60,000 but it can be lower for high earners. It is however, possible to ‘carry forward’ any unused allowances from the three previous tax years. Tax relief on personal contributions is also limited to a maximum of 100% of earnings in the tax year that you make the contributions.
"It’s always a good idea to catch up with your financial adviser if there’s been a change to your financial circumstances, positive or negative – to check on how you can stay tax efficient."
Speak to an expert
If you think you might be facing a 60% tax bill, and would like to speak to Gary or a member of his team, you can arrange a chat by clicking here.