According to figures published by HM Revenue and Customs, the number of higher-rate taxpayers in the UK is expected to rise to 6.31 million, with 1.1 million paying the additional tax rate in 2024/25.
While economic growth and wage inflation have driven taxable income figures, this startling increase in top-rate taxpayers has been partly driven by a five-year freeze on tax allowances. This was announced in the 2021 Spring Budget and extended by two years until 2028 in the then-Chancellor Jeremy Hunt’s Autumn Statement 2022.
The Spring Budget 2023 saw further announcements regarding income tax. The additional tax rate was lowered from £150,000 to £125,140 from April 2023, pulling more individuals into the highest income tax bracket. Furthermore, the annual capital gains tax exemption fell from £6,000 to £3,000 per person, and the tax-free dividend allowance fell from £1,000 to just £500.
Significant changes to taxation and an increase in wage inflation have resulted in a large tax burden for high earners in the UK, highlighting the need for expert tax planning and wealth management.
One of the main focuses when guiding clients is creating a plan that helps them achieve their objectives in the most tax-efficient manner. This article will explore strategies to minimise taxable liabilities while maintaining long-term financial security.
What is the 60% Tax Trap?
One of the most significant tax challenges for higher earners is the 60% tax trap, which affects those with incomes between £100,000 and £125,140. At first glance, this may seem confusing; after all, the UK’s highest tax rate is 45%.
The ‘60% tax trap’ is coined due to the gradual loss of personal tax allowances during this tax band period, which results in an effective tax rate of 60%.
For every £2 you earn above £100,000, you lose £1 of your personal tax allowance. This means that your marginal tax rate increases significantly between £100,000 and £125,140. You can find the most up-to-date allowance figures in our UK Tax Rates and Allowances article.
The good news is that strategic planning can help you avoid the 60% tax trap. Below, we explore potential tax pitfalls for high earners and specific strategies that high earners in the UK can use to reduce their adjusted net income and minimise their taxation.
Tax Pitfalls for High Earners
Being a high earner brings many opportunities but presents several tax-related challenges. If you don’t plan effectively, you may face unexpected tax burdens that can significantly reduce your overall take-home income. These include:
Loss of Personal Allowance
Once your income exceeds £100,000, your entitlement to the personal allowance starts to decrease. The personal allowance is reduced by £1 for every £2 you earn over £100,000, which means that once you reach £125,140, your personal allowance is wiped out entirely.
This reduction increases the amount of your income that is taxed at the higher rate (40%), and for those in the 60% tax trap, this results in an even higher effective tax rate. High earners should, therefore, plan their income and consider ways to bring it below the £100,000 threshold, where possible, to retain their personal allowance.
Loss of Tax-Free Childcare
The Tax-Free Childcare scheme is a government initiative to help parents cover childcare costs. Under this scheme, parents can receive up to £2,000 per child per year towards the cost of childcare. However, high earners lose eligibility for this benefit once their income exceeds £100,000.
For families, this can be a significant financial blow. The loss of this benefit means you must absorb the total cost of childcare, which can be as high as £15,000 per year for full-time care. To manage this, you might explore alternatives such as using the childcare voucher scheme (if still available through your employer) or reducing your taxable income to qualify for the scheme again.
High-Income Child Benefit Charge
The High-Income Child Benefit Charge applies to those earning over £50,000 who are claiming child benefit. As your income rises, this charge reduces the amount of child benefit you can receive. Once your income exceeds £60,000, you are required to repay the entire child benefit amount through the charge.
This is especially problematic for those earning just above the £60,000 threshold, as it essentially wipes out any financial advantage from receiving child benefit. For example, a family with two children could receive up to £1,934 in child benefit annually. However, if one partner earns £62,000, they will have to repay the full benefit.
One way to mitigate this charge is to reduce your taxable income through salary sacrifice schemes or additional pension contributions. These schemes can bring your income below the £50,000 or £60,000 thresholds and allow you to retain more of your child benefit.
Mandatory Self-Assessment Filing
Another important consideration for high earners is mandatory self-assessment filing. Individuals earning over £150,000 must file a self-assessment tax return, even if they have no additional income outside their salary. This is an increase from the previous threshold of £100,000.
The self-assessment process can be complex, particularly for those with multiple sources of income or those who are eligible for various tax reliefs. Failing to file correctly or on time can lead to charges from HMRC.
At DS Burge & Co, we offer tailored self-assessment services to help high earners navigate the process and ensure compliance, avoiding unnecessary fines and maximising tax savings.
Strategies for Reducing Adjusted Net Income
Fortunately, there are several effective strategies that high earners can adopt to reduce their taxable net income, preserve personal allowances, and avoid the 60% tax trap. You can manage your income more efficiently by carefully considering your financial situation and taking advantage of available tax reliefs and strategies.
Increase Pension Contributions
One of the most straightforward and effective ways to reduce your taxable income is to increase contributions to your pension. Pension contributions are deducted from your income before tax, which helps reduce your adjusted net income and could keep you below key tax thresholds.
Contribution Limits:
You can find the current annual allowance for pension contributions for the 2024-25 tax year on our UK tax rates and allowances page. Note that this allowance may be lower if you’ve accessed your pension previously.
The lifetime allowance, which capped the amount you could save in a pension without incurring additional tax charges, was abolished in the Spring Budget 2023.
Benefits of Pension Contributions:
- Tax Relief: Contributions to private pensions benefit from tax relief at your highest marginal rate. Higher-rate taxpayers can claim 40% tax relief on contributions, while additional-rate taxpayers can claim 45% tax relief, meaning that every £1,000 contributed to a pension only costs £600 or £550 after tax relief.
- Preserving Allowances: If you earn £130,000, contributing £30,000 to your pension brings your adjusted net income to £100,000, saving you from the 60% tax trap and retaining your full personal allowance.
Carrying Forward Unused Pension Allowances
You can take advantage of the carry-forward rule if you have yet to use your full annual allowance in previous years.
This allows you to carry forward unused allowances from the last three tax years, potentially increasing the amount you can contribute to the current year and gain further tax relief. This is particularly beneficial for high earners looking to make significant one-off contributions.
Read our Pension Tax Relief for Higher Rate and Additional Rate Taxpayers article for further pension guidance and mitigation.
Consider Investment Strategies
The Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) offer significant tax reliefs for those seeking to reduce their taxable income while exploring investment opportunities.
Enterprise Investment Scheme (EIS):
EIS is designed to encourage investment in higher-risk small businesses. High earners can invest in qualifying small businesses and receive up to 30% income tax relief on investments of up to £1 million. Additionally, gains made from EIS investments are exempt from capital gains tax (CGT) if the investment is held for at least three years. Explore our Enterprise Investment Scheme page for more information.
Venture Capital Trusts (VCTs):
Similar to EIS, VCTs are investments in a fund that pools investor capital to invest in small businesses. VCTs offer 30% income tax relief on investments up to £200,000 per year, provided the shares are held for at least five years.
Both EIS and VCTs offer significant tax relief for high earners, reducing taxable net income and could additionally provide lucrative long-term investments.
Support Charitable Organisations
Charitable donations extend your basic-rate tax band, meaning more of your income is taxed at 20% rather than 40% or 45%. This can be particularly beneficial if you are close to the higher-rate threshold. The most common way to donate to a UK-registered charity is through Gift Aid.
For example, if you made a charitable gift of £100, the charity could receive £25 from HMRC to reclaim the basic rate tax.
As a higher or additional rate taxpayer, you can claim a further £25 (higher rate tax) or £31.25 (additional rate rax) back via your self-assessment for the £125 (gross) contribution you originally made.
You must register for gift aid with a ‘gift aid declaration’ and keep a record of your gifts, which can be no more than four times your total income and capital gains tax payment for the year.
Salary Sacrifice Schemes
Salary sacrifice schemes are an effective way to reduce your taxable income while still receiving valuable benefits. Under these schemes, you exchange a portion of your salary for non-cash benefits such as pension contributions, private healthcare, or an electric vehicle. This approach lowers your taxable income and helps you take advantage of available tax reliefs.
Common Salary Sacrifice Options:
- Pension Contributions: As discussed, pension contributions made through salary sacrifice benefit from tax relief and reduce your adjusted net income.
- Cycle to Work Scheme: This government-backed scheme allows you to purchase a bike and accessories for commuting through your employer, with the costs deducted directly from your pre-tax salary. By doing so, you can lower your taxable income while gaining a tax-free benefit. You save on income tax and national insurance contributions, making this a highly tax-efficient option. Learn more about the tax advantages and how it works in our detailed Cycle to Work Scheme guide.
- Electric Car Schemes: Choosing an electric vehicle through salary sacrifice is a smart way to save on taxes and vehicle costs. In this scheme, your employer leases an electric car on your behalf, and you pay by deducting it from your gross salary. This reduces your taxable income, which in turn helps you stay within lower tax brackets. The lower Benefit-in-kind (BIK) rates for electric vehicles, thanks to their zero emissions, can result in substantial savings for earners. Additionally, you can take advantage of the government’s incentives for low-emission vehicles.
If you anticipate a bonus or a raise that could push your income over £100,000, you could consider deferring part of it to the following tax year or opting for non-cash benefits like those mentioned above.
Conclusion
As a high earner in the UK, managing your taxable income can be complex and requires a proactive and strategic approach. By increasing pension contributions, exploring tax-efficient investment schemes, supporting charitable causes, and using salary sacrifice schemes, you can significantly reduce your tax liabilities while protecting your wealth.
At DS Burge & Co, we specialise in providing tailored tax advice for higher earners and businesses. Whether you’re seeking to reduce your taxable income or require assistance with self-assessment filings, our expert team is here to help. Contact our expert team today to discuss how we can support you in taking a proactive approach to tax planning.