The tax trap

If you earn between £100,000 and £125,140, make sure you avoid the tax trap.

 

A quick run down of the tax trap

You probably know that the advanced rate of tax is 45%, but did you know that you could be paying an effective rate of 67.5% tax on some of your income?

On this page, we'll cover what the tax trap is, who it catches, and a way you can avoid it. You can also watch our video (1min 36secs).

If you live in England, Northern Ireland or Wales, tax rates are different, but the same tax trap still exists.

  • As your income increases above £100,000, your personal tax allowance, or the amount you can earn tax free, reduces. For every £2 of income you earn over £100,000, you lose £1 of personal allowance. And that continues until you pay tax on every penny.

    In Olive’s case she earns £110,000.

    • This means she loses £5,000 of her personal allowance.
    • She therefore not only pays 45% tax on the final £10,000 that she earns.
    • She also pays 45% tax on £5,000 of her income she didn’t previously, due to the personal allowance she has lost.

    In the example below we compare how much of your income falls into each marginal rate of tax. Look closely at the 45% section and see how this part grows as your income exceeds £100,000. Also note how your personal allowance is reduced.

    If Olive puts £10,000 into her pension, she reduces her ‘adjusted net income’ to £100,000. That means she doesn’t lose her personal allowance. She doesn’t fall into the tax trap, and she helps grow her pension, which could give her more money in retirement.

     

  • As your income increases above £100,000, your personal tax allowance, or the amount you can earn tax free, reduces. For every £2 of income you earn over £100,000, you lose £1 of personal allowance. And that continues until you pay tax on every penny.

    In Olive’s case she earns £110,000

    • This means she loses £5,000 of her personal allowance
    • She therefore not only pays 45% tax on the final £10,000 that she earns
    • She also pays 45% tax on £5,000 of her income she didn’t previously, due to the personal allowance she has lost.

    In the example below we compare how much of your income falls into each marginal rate of tax. Look closely at the 45% section and see how this part grows as your income exceeds £100,000. Also note how your personal allowance is reduced.

    If Olive puts £10,000 into her pension, she reduces her ‘adjusted net income’ to £100,000. That means she doesn’t lose her personal allowance. She doesn’t fall into the tax trap, and she helps grow her pension, which could give her more money in retirement.

     

I'll be earning more than £100,000 this year

If you earn £100,000 and receive a £1,000 bonus, your bonus pushes your earnings above the £100,000 limit. This means you'll start to lose some of your personal allowance.

This means you'll face an effective tax rate of 67.5% on the amount over £100,000. In this case, you'll only keep £375 of the extra income. The bonus will also be subject to National Insurance, leaving you with less in your pay cheque.

Remember, it's not just a bonus that can push you over the threshold. HMRC considers all sources of income when it calculates your income tax for each tax year. This includes your salary, dividends, certain types of rental income, and interest. It's important to think about the bigger picture.

Earning more than £125,140?

Once you earn £125,140, you'll lose your personal allowance entirely. This means you'll pay tax on all your earnings. This amount also marks the beginning of the additional rate tax band.

You'll pay 48% tax on your income, while in England, the rate is 45%.

Do you have a young family?

If you and your partner have an adjusted net income of less than £100,000, you could benefit from:

  • up to 30 hours of free childcare each week
  • up to £2,000 of tax-free childcare per year.

And if you earn less than £80,000, you could still be eligible for some child benefit.

For example, Jane takes a bonus, increasing her yearly income from £90,000 to £105,000 per year. This tips her over the £100,000 threshold, so she loses her entitlement of up to 30 hours of free childcare per week and the 20% government top-up (tax-free childcare).

Do I need to complete a tax return?

Because of the way tax relief works on most personal pension schemes, if you’re paying a higher rate of tax and saving into a personal pension, it’s important to complete a Self-Assessment so you can claim the tax relief back that you’re entitled to.

You can read the government website for a full list of who legally must complete a Self-Assessment. This includes anyone earning over £150,000 or who has received any untaxed income, for example from a rental property or dividends.

 

One way you can avoid the tax trap

Topping up your pensions

Adding money to your pension is one way you can help to lower your tax bill and improve your financial future.

If you have a workplace pension, find out if paying in more means your employer does too.

If you need a personal pension, you can easily open one with us.
 

See our pensions

Pension calculator

Pensions are a long-term investment, and you can only access at retirement age.

Many people don't realise how much they might need for retirement. To help you plan, try our pension calculator to see what you could need later in life.

 

Pension calculator

Pensions are a long-term investment. The retirement benefits you receive from your pension plan will depend on a number of factors including the value of your plan when you decide to take your benefits, which isn’t guaranteed and can go down as well as up. The value of your plan could fall below the amount(s) paid in.

 

Looking for financial advice?

If your main income exceeds £100,000 or you have £100,000 in savings, investments, or a personal pension, our partners at Schroders Personal Wealth can give tailored financial advice.

Your initial meetings, which include the presentation of your financial plan, are free of charge. Please note that fees will apply if you choose to take out a product or service. Check your eligibility and book an appointment with Schroders Personal Wealth here.

Schroders Personal Wealth

A look at the details

  • If you’re expecting your income to exceed £100,000 this year, it could be worth checking with your employer to see if it’s possible to top up your workplace pension. This can make sense, especially if they offer to contribute too. Contact your employer directly to find out more.

    Another option is to consider setting up a separate personal pension.

    See our personal pensions

  • It’s easy to open a personal pension with us and start contributing straight away, either on a monthly basis or as a lump sum.

    We offer two different pension options, depending on how involved you want to be in selecting investments.

    By having your pension visible alongside your bank account on the app, it’s easy to keep track of.

    Ready-Made Pension

    Our retirement experts manage your pension investments for you, creating a portfolio that’s suitable for your age and expected retirement date.

    Learn more about the Ready-Made Pension

    Self-Invested Personal Pension (SIPP)

    Gives you the choice of where to invest – putting you in control of your investment strategy and financial future.

    Learn more about Self-Invested Personal Pensions (SIPP)

    Pensions are a long-term investment. What you get back isn’t guaranteed and can go down as well as up. You could get back less than the amount(s) paid in.

  • The current income tax bands for Scotland are as shown in the table below.

    When you reach £125,140 you lose your personal allowance completely and pay tax on every penny you earn.

    It’s also the start of the additional rate tax band, meaning you’d be paying 48% tax (45% in England).

    Tax bands for Scotland

    Band

    Taxable income

    Scottish tax rate

    Band

    Personal allowance

    Taxable income

    Up to £12,570

    Scottish tax rate

    0%

    Band

    Starter rate

    Taxable income

    £12,571 to £14,876

    Scottish tax rate

    19%

    Band

    Basic rate

    Taxable income

    £14,877 to £26,561

    Scottish tax rate

    20%

    Band

    Intermediate rate

    Taxable income

    £25,562 to £43,662

    Scottish tax rate

    21%

    Band

    Higher rate

    Taxable income

    £43,663 to £75,000

    Scottish tax rate

    42%

    Band

    Advanced rate

    Taxable income

    £75,001 to £125,140

    Scottish tax rate

    45%

    Band

    Top rate

    Taxable income

    Over £125,140

    Scottish tax rate

    48%

  • The tax bands are different, but that doesn’t mean the tax trap doesn’t impact you. A higher rate taxpayer pays 40% in income tax, which means when you lose your personal allowance, you’re paying an effective rate of 60% tax on the income you’re earning between £100,000 and £125,140.

    The current income tax bands for England, Wales and Northern Ireland are:

    Tax bands for England, Wales and Northern Ireland.

    Band

    Taxable income

    Tax rate

    Band

    Personal allowance

    Taxable income

    Up to £12,570

    Tax rate

    0%

    Band

    Basic rate

    Taxable income

    £12,571 to £50,270

    Tax rate

    20%

    Band

    Higher rate

    Taxable income

    £50,271 to £125,140

    Tax rate

    40%

    Band

    Additional rate

    Taxable income

    Over £125,140

    Tax rate

    45%

The information on this page reflects the current tax year. It’s important to be aware that tax depends on your individual circumstances, and these can change year-on-year. Tax rules can also change.

You might also like

Personal Savings Allowance

What's a Personal Savings Allowance (PSA) and why does it matter to me?

What's a PSA?

Combine your pensions

Having all your old pensions together could make it easier to plan for your retirement.

How to combine pensions

What is a pension?

We're here to help if you feel confused by pensions and how they work.

Pensions explained