The hidden 60% tax rate – and how to avoid it

You’ll find no mention of it in the statute books but Britain’s tax regime imposes a tax rate of 60% on people whose income exceeds £100,000 a year.

Many may have no inkling of this tax band until they find themselves caught in it; some may even remain unaware of it when they are paying it – especially if their salary is less than £100,000 but a bonus boosts their total income beyond that figure.

If so, they will also be unaware that this 60% tax is easily and legally avoided by paying more into a pension.

Here we explain what this 60% tax is and how to help your employees avoid it.

You can thank the crazy complexity of Britain’s tax system. It’s true that the highest income tax band is 45%, which applies to income of more than £125,140 a year. However, there is effectively a 60% band between £100,000 and £125,140. This is because, once total taxable income exceeds £100,000, each extra pound of income results in the loss of 50p of tax-free personal allowance, which is the first £12,570 of income.

The 60% figure applies in England, Wales and Northern Ireland. Scotland, which has some independence over tax policy, has a plethora of tax rates but a similar principle applies. However, because in Scotland the rate of tax at £100,000 is 45% and not 40%, the effective rate between £100,000 and £125,140 is 67.5%.

To these already sky-high tax rates we can add 2% in National Insurance, so the final deduction from pay packets comes to 62% (in England, Wales and Northern Ireland) or 69.5% (in Scotland).

Incidentally, it’s also at £100,000 a year that parents lose entitlement to 30 hours a week of free childcare, so there is even more reason to help your employees to bring taxable income down below that figure by making pension contributions.

In all parts of the UK the 60% (or 67.5%) band ends at £125,140. At this point, the £25,140 in earnings over £100,000 is enough to wipe out your personal allowance entirely. Above £125,140, the effective rate of tax on each extra £1 of income reverts to 40% in England, Wales and Northern Ireland (in Scotland a 48% band starts at £125,140).

This does not mean, of course, that people can give a sigh of relief and forget about it in the knowledge that their marginal tax rate is ‘only’ 45% (or 48% in Scotland): they will have still lost all their personal allowance, not to mention childcare entitlement. We’ll now explain how you can help your employees to get both of them back.

In a word: by making pension contributions. Paying money into a pension reduces taxable income and, if your pension contributions reduce taxable income to less than £100,000, the personal allowance (and childcare entitlement) will be restored in full.

Case study: An employee earns £110,000 and wants to bring their taxable income back to £100,000 to get out of the 60% (or 67.5%) tax band. They can do this by making an extra contribution of £10,000 from salary into the company pension scheme or to a private pension such as a self-invested personal pension (SIPP).

It’s a slightly different process if your scheme offers ‘salary sacrifice’: here the salary is reduced to £100,000 and the employer makes the contribution to the employee’s pension to compensate (because of the complexities of tax and National Insurance, salary sacrifice is normally a more tax-efficient way to pay money into your pension).

Charitable donations reduce taxable income too, so employees should also keep track of them.