A simple guide to the £100k Tax Trap

There is no change to your income tax band when you hit earnings of £100,000 (the next tax rise kicks in at £125,140).

However, those earning between £100,000 – £125,140 are faced with an effective tax rate of 60% thanks to something known as the ‘£100k tax trap’.

This happens because when you reach this level of earnings, you start to lose your ‘personal allowance’, which is the amount you can earn before you pay any tax.

Parents also face a double-hit, as many government childcare schemes are lost once one parent reaches the £100k earnings threshold. This can mean forking out thousands of pounds in childcare fees that you weren’t previously needing to budget for.

It is. But there are some important considerations to take into account when making decisions about what’s best for you and your money.

The way to beat the tax trap is to reduce your adjusted net income, and there are several ways to achieve this perfectly legally.

Your adjusted net income is your gross income minus your pension contributions, and any trading losses and/or Gift Aid donations you’ve made.

Therefore, one of the best ways to reduce your adjusted net income is to redirect more of your earnings into your pension. By putting your additional earnings into your pension, you still get to personally benefit from your increased income, but you don’t lose your personal allowance, and your childcare allowances remain in place. Plus, you’ll also get 40% pension tax relief on your pension contributions.

There are a couple of downsides to be aware of, though. Any money you put into your pension is locked away until retirement. The earliest you can access it is aged 55 (rising to age 57 from April 2028). So, you won’t be in a position to use your new extra income for current living costs or treats like a holiday or new car. And there are limits to how much the government will allow you to save this way. The current standard annual allowance (the amount you can put into your pension each year) is £60,000, but it can be lower for high earners. You can ‘carry forward’ any unused allowance from the three previous tax years, however, but it’s best to consult a financial or tax advisor for the most suitable action to take if this is relevant to you.

You could also consider making charitable donations to bring your salary down.

Charitable donations through Gift Aid extend your basic rate tax band, reducing your higher-rate exposure. For example, a £1,000 donation could increase your basic rate band by £1,250.

And there are other ways too. For a more complete guide, request our Free £100k Tax Trap Guide.