The £100,000 tax trap is a mechanism that we do not believe encourages growth!
It occurs because the personal allowance, which is the amount of income you can earn tax-free each year, is tapered away for people who earn over £100,000.
This means that for every £2 you earn over £100,000, you lose £1 of your personal allowance. As a result, people who earn between £100,000 and £125,140 can end up paying an effective tax rate of 60% on a portion of their income. However we are going to tell you how to reclaim it!
How to mitigate the £100,000 tax trap
There are a few things that you can do to mitigate the £100,000 tax trap:
- Reduce your income. This could mean asking for a lower salary, taking a career break, or working part-time. We appreciate this is not always an option and does not make sense for all families.
- Increase your pension contributions. Pension contributions are deducted from your salary before tax is calculated, so they can help to reduce your taxable income. It is worth reading on to see the actual reduction in take home pay is not as significant as you may think.
- Make charitable donations. Charitable donations are also deducted from your salary before tax is calculated, so they can help to reduce your taxable income.
The example below shows the difference a personal pension contribution of £25,140 can make for someone with income of £125,140.
We have assumed an employer National Insurance rate of 13.8% on earnings over £9,100 and an employee rate of National Insurance of 12% on earnings between £12,570 and £50,270 and 2% above £50,270 for the whole tax year.
| Pension contribution | Before | After |
| Taxable income | £125,140.00 | £125,140.00 |
| Personal allowance | – | £12,570.00 |
| Employee NI | £6,021.40 | £6,021.40 |
| Employer NI | £16,013.52 | £16,013.52 |
| Income tax | £42,516.00 | £32,460.00 |
| Personal contribution (net) | – | £20,112.00 |
| Employer pension contribution | – | – |
| Net income | £76,602.60 | £66,546.60 |
A pension contribution of £25,140 (including the higher rate tax relief) only results in a reduction to income after tax of £10,056. The difference is £15,084, giving an effective tax relief rate of 60% [£15,084/£25,140 = 60%].
Note that the pension contribution of £25,140 extends the amount of income subject to basic rate tax by this amount. So, £62,840 [£37,700 plus £25,140] is subject to basic rate tax, with the balance of taxable income of £49,730 subject to higher rate tax.
If this is done via salary sacrifice then the tax relief increases to an effective tax rate of 67% due to national insurance savings.
We hope you found this useful and please share with anyone that you think may benefit from this, we are always happy to help here @ Clarity Wealth Limited
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