For many people, earning £100,000 is a significant financial milestone in their career. It represents career success, higher disposable income and more financial freedom. However, crossing the six-figure threshold may not be as rewarding as it initially appears due to complex UK tax laws.
The £100k earnings trap is becoming an increasingly important area of financial planning for professionals and business owners.
While earning more would generally be expected to increase take-home pay, the UK tax system creates an unexpected consequence once adjusted net income exceeds £100,000.
Above this level, an individual's Personal Allowance begins to taper. This creates an effective 60% income tax rate on earnings between £100,000 and £125,140.
Understanding how the earnings trap works, and the planning opportunities available, can help individuals make more informed financial decisions and potentially reduce unnecessary tax.
How Does the £100k Tax Trap Work?
First, it is important to understand how the Personal Allowance works.
Most individuals in the UK are entitled to a Personal Allowance of £12,570 each tax year. This is the amount that can normally be earned before income tax becomes payable.
Income above this level is generally taxed as follows:
● Up to £12,570 – 0% tax (Personal Allowance)
● £12,571 to £50,270 – 20% tax (Basic Rate)
● £50,271 to £125,140 – 40% tax (Higher Rate)
● Over £125,140 – 45% tax (Additional Rate)
Once adjusted net income exceeds £100,000, the Personal Allowance begins to reduce. For every £2 of income above £100,000, £1 of Personal Allowance is lost.
By the time income reaches £125,140, the Personal Allowance has been completely removed.
As a result, individuals within this income range not only pay higher-rate tax on additional earnings but also lose part of their tax-free income. This creates an effective tax rate of 60% on earnings between £100,000 and £125,140.
This often becomes relevant following a pay rise, bonus, dividend payment or increase in other taxable income.
How to Reduce Adjusted Net Income and the Impact of the £100k Tax Trap
There are several planning opportunities that may help reduce the impact of the earnings trap.
Pension Contributions
Pension contributions are often one of the most effective solutions, as they typically reduce adjusted net income for tax purposes.
For example, an individual earning £110,000 could make a £10,000 pension contribution and potentially restore some or all of their lost Personal Allowance.
In some circumstances, this can provide a particularly valuable level of tax relief while also increasing retirement savings.
Salary Sacrifice
Where available through an employer, salary sacrifice can be another effective option.
By exchanging part of a salary for an employer pension contribution, taxable income can be reduced while pension funding is increased.
Charitable Donations
Gift Aid donations can also reduce adjusted net income.
While tax savings should not be the sole reason for charitable giving, Gift Aid can help restore lost Personal Allowance while supporting causes that are important to the donor.
The most appropriate approach will depend on an individual's income, objectives and wider financial circumstances.
Losing Your Personal Allowance Over £100k: Other Hidden Traps
The loss of the Personal Allowance is not the only issue to be aware of. There are several other factors that can increase the cost of exceeding the £100,000 threshold.
● Bonuses and one-off payments - A bonus may temporarily push income into the £100,000 to £125,140 range, resulting in a larger tax liability than anticipated.
● Investment and rental income - Additional income from investments or property can contribute towards adjusted net income and may unexpectedly trigger the Personal Allowance taper.
● Free childcare entitlements - Individuals with adjusted net income exceeding £100,000 may lose eligibility for Tax-Free Childcare and certain funded childcare schemes. For some families, the value of these lost benefits can significantly increase the overall cost of exceeding the threshold.
Tax Planning for High Earners: Your £100k Tax Trap Questions Answered
In summary, the £100k earnings trap is not simply about paying higher-rate tax. The gradual withdrawal of the Personal Allowance can result in a significant increase in the tax paid on additional income and, in some cases, the loss of valuable benefits.
Understanding the available planning opportunities may help reduce the impact and improve overall tax efficiency.
What is the £100k earnings trap?
The £100k earnings trap refers to the gradual withdrawal of the Personal Allowance once adjusted net income exceeds £100,000, creating an effective 60% tax rate on part of an individual's income.
At what income do I lose my Personal Allowance?
Your Personal Allowance begins to reduce once adjusted net income exceeds £100,000 and is completely lost when income reaches £125,140.
Why is the effective tax rate 60%?
For every £2 earned above £100,000, £1 of Personal Allowance is lost. This means individuals pay higher-rate tax on the additional income while also losing tax-free income, creating an effective tax rate of 60%.
Can pension contributions help reduce adjusted net income?
Yes. Pension contributions generally reduce adjusted net income and may restore some or all of a lost Personal Allowance, depending on individual circumstances.
Can salary sacrifice help reduce adjusted net income?
Where available, salary sacrifice arrangements can reduce taxable income and help keep adjusted net income below the point at which the Personal Allowance starts to reduce.
Should I seek financial advice if I’m affected by the £100k tax trap?
The most appropriate solution will depend on your income sources, pension allowances, financial objectives and wider tax position. Professional financial advice can help identify planning opportunities and ensure they are implemented appropriately.
Looking for Advice on Tax Planning for High Earners?
If your income is approaching or exceeds £100,000, understanding how the £100k tax trap could affect you can be an important part of your wider financial planning.
At Two10 Investment Services, we can help you understand your financial position and explore the planning opportunities available based on your individual circumstances.
Get in touch with our team to discuss your financial plans and find out how we can help.
Important Notes
National Insurance
The examples in this article focus on Income Tax and the withdrawal of the Personal Allowance and do not take into account any potential National Insurance savings. In certain circumstances, pension contributions made through salary sacrifice may also result in National Insurance savings, which could provide an additional tax advantage. However, the availability and extent of these savings will depend on the arrangement in place and individual circumstances.
Scottish taxpayers
The Income Tax bands and rates referred to in this article apply to taxpayers in England, Wales and Northern Ireland. Scottish Income Tax bands and rates differ and, in some circumstances, the withdrawal of the Personal Allowance can result in a higher effective marginal tax rate due to the earlier application of Scotland's 45% tax band.
