This article will go through the issues that arise when your total earnings hit £100k. Please note that although the Personal Allowance issue applies to the whole of the UK, for Scottish taxpayers the tax trap percentage is 63% and not 60%!
Table of contents:
Personal Allowance Loss
It is quite well known that when you have income of £100k you start to lose your personal allowance. You lose your personal allowance by £1 for every £2 you go over, so by the time you earn £125,140 the personal allowance is totally lost.
This means the effective tax rate between £100k to £125,140 is 60%! This is 20% higher than the higher rate tax rate of 40%.
What many do not appreciate is that it is based on all taxable income and you can pay tax on tax-free money due to the £100k tax trap! Confused? The reason for this is that the earned income utilises the personal allowance before being subject to tax. The 4 main tax-free allowances for a higher rate taxpayer are:
- £500 for interest
- £500 dividend allowance from 24/25
- £1,000 other income
- £1,000 property income
Here is an example.
If you earn exactly £100k and had interest of £350 and dividends of £250, neither the interest or dividends will be subject to tax but you will have now earned £100,600. This means that you will therefore lose £300 of your personal allowance. The result is a tax payment of £120 just because you had non-taxable other income! This represents 20% on the earnings and also shows where the extra 20% arises in addition to the higher rates of tax of 40%.
Childcare Loss
A more recent concern for higher earners is the loss of tax-free childcare. We do not advise on the specifics of tax-free childcare, but can advise on how to keep your adjusted net income to a threshold to meet the tax-free childcare requirements.
When your adjusted net income is over £100k you lose the tax-free childcare. HMRC have a page which is well written regarding the adjusted net income calculation.
As accountants, we often ask clients if they have any savings interest (the most common source of income outside earnings) and we are met with:
- “I don’t have any”
- “It’s trivial”
However, every pound counts! Imagine if you earn £99,990 and you happen to have forgotten about an account that earns a trivial £11 of interest. This has pushed your earnings to £100,001 and now means for the £1 you went over the £100k you lost £2,000 of the tax free childcare (for 1 healthy child).
Protecting against the £100k tax trap
You can protect against the £100k tax trap in a few ways.
The first is ensuring that all of your reliefs and allowances are claimed. This means keeping a record of any charitable donations eligible for gift aid. The donations that you make during the year can help keep your adjusted net income below the £100k. Often people’s donations are likely to run in the £100’s rather than £1,000’s so for those earning higher amounts you may need to think more about pensions.
Using a pension is likely to be the best option. There are 3 ways to do this, with the most common being either:
- Salary Sacrifice – whereby you sacrifice income or a bonus for your employer to pay it into your pension
- Personal Pension Contributions – known as Relief at Source (RAS) contributions
The good thing about using the pension is that it is a very tax-efficient saving tool. This especially the case between the £100k to £125,140 income threshold. The money within the pension scheme benefits from tax-free growth.
The downside is that once the money is in the pension, with the exception of terminal ill health, you are unable to access your pension until 10 years before your retirement date. This means you won’t be able to access these funds in reality, so you need to be sure you won’t need the money for the foreseeable future.
Whether you Salary Sacrifice into your Works Scheme or set up a Personal Pension Scheme, is not something we can advise on and you would want to go to a pensions or financial adviser.
Where you make gift aid or RAS contributions these are grossed up 100/80 and you get your additional relief via your Self-Assessment Tax Return. You may want to get your tax code updated to receive relief quicker than via the Tax Return, but care should be taken to not claim too much.
Payroll Issues
The other issue with going over £100k is that HMRC do not update your tax code quickly enough, which can result in large unexpected tax liabilities, when you believe your employer has been taking the right tax from your tax code.
A typical tax code where you do not get any taxable benefits is 1257L (24/25 tax year), which means a tax free allowance of £12,570.
If your earnings are say £95,000 but you get a bonus to take these up to £115,000 in March, this means you are £15,000 over the £100k threshold, resulting in a loss of £7,500 of the personal allowance. Technically the correct tax code for you would be 507L.
The issue can be that your employer needs to implement the tax code issued by HMRC. HMRC do not know what bonus your employer is planning. Taxpayers who have not had any interaction with HMRC previously, do not always know they can contact HMRC to build some tax into the tax code.
The issues do not stop there. HMRC might not recognise you have breached the £100k in the tax year until they have issued a tax coding notice in the next year, despite having the information under the Real Time Information system. This can sometimes lead into issues into the 2nd year. By the time HMRC recognise this, to catch up, more tax needs to be collected from your pay. The maximum amount of tax that can be taken from your net pay is 50% of earnings.
Assistance
This article does not cover everything you need to be aware of. If you require any further information or assistance with the £100k tax trap and protecting yourself with the tax-free childcare issue please contact us. A member of our team will be happy to help.
