Professionals accelerating up the corporate ladder or high earners face complications as their incomes break through different thresholds. A pair of rules where you earn two pounds and lose a pound creates a real dilemma for people who want to plan their long-term futures. Known as the “60% Tax Trap” and “Taper Tax”..

We have a range of clients that will face the complications below in the coming years or at present. So, we want to highlight the financial considerations for your savings and retirement plans.

For dual citizens, the UK tax and saving landscape can be different from what they’ve seen previously in their home market. Whilst the effective tax trap and taper reduction may affect only a small majority of people but it can have severe impacts for their long-term financial planning. One solution is to use a Lifetime ISA to get bonuses and use this vehicle as an alternative savings vehicle.

What is the 60% tax trap, and how does it work?

The tapering of the personal allowance means someone earning between £100,000 and £125,140 faces an effective 60% tax rate on that portion of their income.

Tax implications of earning over £100K?

Taper relief (or the personal allowance taper) affects taxpayers on incomes over £100,000 and cuts the tax-free personal allowance over time. It’s a very important thing for high earners — particularly the folks who want to maximise take-home pay and keep their taxes in check. What taper relief is, who it impacts, and how to live with it.

What Is Taper Relief?

• Personal Allowance: This is how much you get tax-free; currently £12,570 (2024/25 tax year).
• Tapering: Each £2 earned over £100,000 £1 is reduced to your individual allowance. Until the allowance is fully wiped out on incomes of £125,140.
• Effective Tax Rate: This tapering leaves a marginal tax rate of 60% on incomes from £100,000 to £125,140. This is because £20 of the personal allowance is removed for every £100 of income, plus the £40 income tax in this bracket. a total effective tax rate of 60%.

Who Benefits from Taper Relief?

Taper relief impacts those with income of more than £100,000. It’s especially true for professionals, business owners and people on high, variable incomes who may forget to put a strategy when earning over £100,000 mark and activate the taper.

Practical Example of Taper Relief

Example: Income of £110,000

• Profit After Fees: £110,000 – £100,000 = £10,000.
• Reduction in Personal Allowance: £10,000 / 2 = £5,000.
• New Personal Allowance: £12,570 – £5,000 = £7,570.
• This means £5,000 more income is now 40% taxed – a total of £2,000 more on the tax bill.

When you make £125,140 and above, the entire personal allowance goes, with no tax at all payable.

How to Handle Taper Relief Impact?

Pension Contributions: Contributions to a pension are tax-deferred. Salary sacrifices or personal pensions contributions will if bringing your income below £100,000 can be used to reinstate the personal allowance.

Gift Aid Donations: Gift Aid donations to registered charities are reduced in taxable income too, and could mitigate tapering.

Why Is Taper Relief Significant?

With the elimination of the personal allowance, you can end up paying more taxes than you planned, and it can affect disposable income and budgeting. Awareness and management can limit its effects.

Key Takeaway

High earners should take stock of their income and tax situation and make pension contributions or invest in LISAs to avoid taper relief. Only financial counsel can make sure that you’re getting the best possible solution for your specific situation.

By learning and utilising taper relief, you can lessen its effects and keep more of your hard-earned money.

Effective tax rate calculator. Are you in the 60% trap?

Effective 60% Tax Rate Calculator

See how your income is taxed due to the tapering of the personal allowance. For every £100 of income between £100,000 and £125,140, you take home only £40: £40 is deducted in Income Tax, and £20 is lost from the tapering of the personal allowance.

Reduced pension allowance for higher earners

The taper, as it’s also known, limits the amount of money that top earners – defined here as those earning more than £260,000 a year – can pay into a pension every year, and be exempt from tax. The taper is not a major problem for everyone but it is a real pain when people are confined by it. The reduction in the annual allowance is a huge issue for those on high incomes trying to pay into pensions. It reduces the maximum annual pension savings allowance for those on adjusted incomes over £260,000 and threshold incomes over £200,000 (from tax year 2023/24).so, what it is, who it effects, and how to deal with it.

What Is the Tapered Annual Allowance?

• Average Annual Allowance: £60,000 (amount you can save into a pension free of tax every year).
• Tapering: With an adjusted income of over £260,000, your allowance is reduced by £1 per £2 over £260,000.
• Minimum Allowance: The allowance decreases to a minimum of £10,000 when adjusted income exceeds £360,000. This has increased from £4,000 2020-2023.

Key Definitions: Adjusted Income vs. Threshold Income

Threshold Income:

• Represents all taxable income (eg: salary, rent, dividends).
• Excludes personal pension contributions under the Net pay arrangement. This means your contributions are taken from your pay before your wages are taxed.
• Removes items like taxed death benefit received.

Adjusted Income:

• Includes all taxable income.
• Adds in employer pension (and salary sacrifice contributions after July 2015).
• Deducts taxed death benefits.

Practical Example of Tapering:

• Example: Adjusted Income of £300,000
• Excess earnings beyond £260,000: £40,000.
• Limitation of allowance: £40,000 / 2 = £20,000.
• New annual allowance: £60,000 – £20,000 = £40,000.

What If Income Exceeds £360,000?

It is £10,000 per year, no matter how much more the earnings exceed £360,00. This is the floor amount.

Effect and Approaches to Managing Tapering Reduction

• Earners could be subject to sudden taxation if they contribute more than their tapered allowance.
• Any additional contributions will be subject to individual tax at the marginal rate.

Strategies:

Carry Forward Unused Allowance:

• Use unused allowances from the last three years if you’ve been in a pension scheme during that time.
• Note: Tapering is retrospective, so the amount not claimed is the lower allowance.

Optimise Contributions:

• Make sure contributions are not over the tapered amount.

Use Lifetime ISA allowance:

• For individuals on taper relief, a LISA offers an effective way to diversify savings, benefit from a government bonus, and achieve long-term growth.
• This doesn’t replace the tax advantages of a pension, it complements retirement planning by adding flexibility and tax-free benefits, especially faced with pension payment restrictions.

Benefits of financial advice

The rules are a bit nitty, so get individual advice if your income is above £200,000. The cap on the annual allowance means that high earners get less pension tax relief. The rules are complex, but understanding adjusted and threshold income rules, carry-forwards, and planning ahead can mitigate the impact. If you need professional help to understand these complex regulations and maximise your pension contributions, find a professional advisor. Edale can assist with this.