Britons urged to ‘take action now’ as 400,000 in danger of falling into tax trap (Image: GETTY)
Nearly 400,000 people are at risk of falling into the ’60 percent tax trap’, but they could prevent losing thousands by taking action now, an investment expert has said.
For those who earn between £100,000 and £125,140 in any tax year, a proportion of their income will effectively be taxed at a staggering 60 percent.
This is because, while the tax rate is 40 percent, the person’s annual personal allowance reduces by £1 for every £2 until £125,140 when it is lost completely, as explained by Andrew Prosser, head of investments at InvestEngine.
Taking the average income in the ‘tax trap’ range of £110,000, Mr Prosser explained that this income incurs £4,000 in higher rate tax on the £10,000 exceeding the threshold.
Additionally, it loses £5,000 of the personal allowance, subjecting it to 40 percent tax, costing another £2,000.
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People could collectively lose around £2.3million in taxes if they don’t act. (Image: GETTY)
Mr Prosser added: “In total, only £4,000 out of the £10,000 is retained – a 60 percent effective tax rate.”
InvestEngine’s research and analysis suggests around 1.2 million people earn £100,000 or more in the UK. Of those, 862,000 are additional rate taxpayers (earning £125,140+). This leaves around 394,500 people in the £100,000 to £125,000 ‘trap’.
Mr Prosser said: “Assuming an average income of £110,000, that’s a £6,000 ‘loss’ as a result of that effective 60 percent rate, costing them a combined £2.3million.”
How ‘tax trap’ earners can avoid the 60 percent rate
With pension contributions benefiting from tax relief at the marginal rate, the cost for a 40 percent taxpayer to receive a £1,000 contribution to their pension would be only £600.
In contrast, Mr Prosser said it would cost a basic rate taxpayer £800.
He added: “Pension saving is widely regarded as the most tax-efficient way to save for higher earners.”
When looking at those in the ‘tax trap’ specifically, Mr Prosser said making a Self-Invested Personal Pension (SIPP) contribution could avoid that trap “completely”.
He explained: “If someone earning £110,000 were to pay £10,000 into a self-invested personal pension (SIPP), their adjusted net income would fall to £100,000, reinstating their full personal allowance and boosting their pension pot by £10,000.
“The pension annual allowance is the most an individual can pay into their pensions in a single tax year, and still receive tax relief. “
The allowance was previously set at either £40,000 or 100 percent of someone’s qualifying earnings (whichever is lower), but in April 2023 the annual allowance increased to £60,000.
Yet research from InvestEngine found over half (51 percent) of people earning over £100,000 don’t have a SIPP, and two-thirds (67 percent) did not realise they had a pension allowance of £60,000, instead believing that the limit was just £10,000.
Mr Prosser is urging those who have not made the most of their pensions to do so before April 5.
He said as many as 77 percent of those surveyed earning £100,000 or more say they are concerned their current (non-SIPP) pension is not on track to ensure a comfortable retirement, yet they are not making the most of pension contribution tax relief.
Additionally, he continued: “Our data shows that just 21 percent of those earning £100,000 or more have made a lump sum payment into their pension even though doing so could not only boost their pension pot but is an extremely tax efficient way to invest, as illustrated by the way it can mitigate the ‘60 percent tax trap’.
“For additional rate taxpayers, pension relief is even greater, as a £1,000 contribution would only cost them £550.
“Therefore, if an additional rate taxpayer was to make the full £60,000 contribution, it would only actually cost them £33,000.”
