Earning over £100k? Avoid the 60% tax trap

The topic of employee pay can be a real can of worms. At first glance, it’s simple: your staff will earn a set wage and be taxed depending on how much they earn. Rates increase incrementally, and no-one pays more than the highest tax band of 45% (48% in Scotland).

Peel back the lid, however, and you’ll realise that’s not entirely true. Legislative loopholes mean workers on a higher salary might end up paying closer to 60% in tax – cutting short celebrations for those who have just received a pay boost or a promotion.

Below, we’ll explain this 60% ‘tax trap’ in simple terms, so you can understand why it occurs, when, and how it might impact your tax bill. We’ll also advise employers on how the tax quirk affects hiring, and how you can support staff affected by the rate.

What is the 60% tax trap?

The ‘60% tax trap’ is a wrinkle in the UK tax code which causes those earning at least £100,000 to pay a larger effective tax rate than expected. You won’t hear HMRC mention the tax trap because officially, it doesn’t exist. UK tax brackets technically only go up to 45%.

But a flaw in tax law means that, once someone’s paycheck hits the £100k threshold, their tax-free allowance begins to decrease. This can lead to a surprisingly big bill at the end of the year. Sometimes, they can end up paying 60% tax – or higher – on earnings.

It can also limit access to the government’s newly-announced childcare support measures. Working parents on a salary of over £100k a year do not qualify for the perk – despite childcare costs now reaching up to £1,781 a month in the UK.

Tax implications of earning over 100k

Before we explain how the 60% tax trap impacts take-home pay, you’ll need to understand three relevant tax terms:

• Income Tax: a tax paid on all earnings. In FY 2024/25, UK tax brackets range from 20%-48%, based on how much you earn and in which country you are based (in Scotland, rates are higher than in England, Wales, and Northern Ireland).
• Personal Allowance: the amount of money a UK worker can earn tax-free. For the 2024/25 tax year, the personal allowance is set at £12,570 for all UK employees.
• National Insurance: a tax paid on wages, salaries, and company profits (for sole traders). NI rates start at 8% for earnings over the personal allowance. In FY 2024/25, high earners pay an extra 2% on earnings over £50,270 a year.

The standard personal allowance prevents most employees from paying a rate of income tax above 45% (48% in Scotland). That line of tax defence disappears once you join the 4% of UK workers who earn £100,000 a year, however.

At this level, earners officially pay income tax at 45%. But, their personal allowance also tapers by £1 for every £2 they earn over £100,000.

It’s incredibly complicated to grasp, but losing the allowance essentially creates a marginal tax effect, whereby high earners end up paying around 60% tax on earnings over £100,000 – plus 2% in NICs (Scottish taxpayers could even be charged up to 69%).

Example: Jonah makes £100,000 a year and gets a £1,000 bonus. He’ll pay the standard higher rate tax (45%) on the entire bonus, leaving him with £550 after the initial tax.

However, because he earns over £100,000 annually, he’ll also lose £1 of allowance for every £2 he earns over the £100k threshold. This lost allowance (£500) is taxed at his normal rate (45%) which means he loses a further £225 to the taxman. 

As a result, Jonah only gets to keep £325 of his £1,000 bonus. It feels like he was taxed 67.5%, even though the actual tax rate on the bonus was 45%.

Once an individual’s earnings reach £125,140 or more per year, they’ll have no personal allowance left, so the tax rate returns to 45%.

How to reduce your tax rate

It’s tempting to see the 60% tax rate as a wealth trap that affects only the very richest in society. But, as tax thresholds remain frozen and inflation erodes the value of salaries, it’s smart for anyone earning over £90,000 a year to keep the loophole on their radar.

Frugal workers might also be punished. Your taxable income spans earnings from multiple sources, like interest earned on savings accounts or running a side hustle. With rising interest rates, the tax owed on this extra income could lose you your personal allowance.

Self-employed workers should take particular note of the risks, given their personal income directly correlates to company profits. When deciding how much to pay yourself as a business owner, the 60% tax trap must be food for thought.

If you have recently entered into the £100k tax bracket, here are three ways to reduce your tax rate fairly and legally:

1. Contribute more to your pension

Paying into a pension pot can save you money today, and in future. Pension contributions are tax-free which means that whatever amount you put towards your retirement fund will also lower your taxable income; benefitting yourself instead of HMRC.

Example: Anita earns £115,000 a year. She currently pays 10% (£11,500) into her pension each year and is left with £103,500 net income, so she’ll take home £50,616 after tax.

If she increases her pension contribution to 15% (£17,250), Anita will be left with a net income of £97,750, so she’ll take home £49,896 after tax.

After increasing her pension contributions by 5%, Anita takes home just under £1,000 less per year after tax, despite paying an additional £5,750 into her pension.

2. Make charitable donations

Another way to reduce your taxable income – and spread a bit of joy at the same time – is to give the money you’d be taxed on to charity, instead.

All donations made to registered charities in the UK qualify for gift aid, which allows the charity to reclaim income tax on the amount given for a bigger contribution to the cause.

3. Speak to a financial adviser

The ins and outs of UK tax law are complex, to say the least. The Startups team have been writing about employee payroll and taxes for decades, but we can’t give individually customised recommendations for your own circumstances. For sound financial advice, payroll service providers offer bespoke help based on your exact payslip, take-home pay, and taxes. You can also speak with a small business financial adviser to consult on the specifics of your tax recommendations.

If you’re expecting a raise, bonus, or role change that might affect your tax bracket; a payroll expert can estimate the impact on net pay and advise if it’s a smart decision.

Advice for employers: how to support high-earning employees

Discovering that a salary top-up actually leaves workers worse off due to the 60% tax trap can be a nasty shock for employees.

It’s also an issue for organisations because, as their salary reflects, high-income employees tend to be your most valuable and experienced workers. So how do you show a talented worker your appreciation without lumping them with a huge year-end tax invoice?

Here are three methods to support employees who are affected by the tax trap:

1. Promote pension contributions:

If you haven’t already, enrol your team onto a salary sacrifice pension scheme and encourage them to pay more into the pot. As previously stated, this will allow employees to reduce their taxable income without you needing to freeze pay.

Workers may be frustrated they have to wait longer to access their hard-earned wonga. HR teams should provide educational resources to make clear how they might access these benefits early through phased retirement.

2. Benefits and bonuses:

Cash isn’t the only way to motivate team members. Consider offering employee benefits that aren’t taxed as heavily as salary, such as a subsidised gym membership or health insurance.

Childcare vouchers are another option. People earning over £100,000 a year do not qualify for childcare support from the government, so any measures that help working parents – such as flexible working – might be more welcomed by mums and dads.

3. Financial planning resources:

When in doubt, ask the experts. Bringing in a third-party advisor or financial wellbeing app, like Mintago, will help them get to grips with complex tax legislation and how it relates to their savings plans; two areas that can be particularly confusing for employees to understand.

Financial wellness programs are especially in-demand in today’s economy. As the cost of living crisis batters staff wages, providing advice on how to get the most out of their salary may prove to be as helpful to employees as a pay rise this year.

Related reading:

• How much should you pay your staff
• TaxScout’s guide to pension tax relief for 60% tax trap
• Full list of tax changes for 2024