Hitting the magical six figures for your income is a landmark moment in your career and definitely deserves the popping of a champagne cork or two.
Just be aware that anything you earn over this amount means you’re at risk of being taxed at a very hefty 60%. The good news is that, as ever with labyrinthine tax laws, there’s a way to limit this potential financial hit.
Everyone can earn a certain amount of money without being taxed on it. HMRC calls this the Personal Allowance, which currently stands at £12,570. Here are the current tax bands.
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Once you start earning £100K, for every extra £2 you earn, your Personal Allowance is reduced by £1. So the more your Personal Allowance reduces, the more tax you’ll be liable for.
For example, if you earn £101,000, you’re £1000 over the line in the sand and so your Personal Allowance is reduced by £500.
If you earn £125,140 or more your Personal Allowance is reduced to nothing. This is because you are £25,140 over £100K (the Personal Allowance amount of £12,570 x 2).
The maths is complicated but the bottom line is that you’re paying an income tax rate of 60% for the income between £100,000 and £125,140. But there is a way to stop the government taking a majority of money: your pension can come to the rescue.
Pensions v the taxman
If that income between £100,000 and £125,140 is getting taxed at 60%, you’ll be taking home £10,056 of it. That’s quite a reduction from the gross amount of £25,140.
But if you put £25,140 into your pension – the amount you earn over £100K – Tax Relief means it gets topped up by 25% by the government.
That means your £25,140 becomes £31,425. Instead of giving £15,084 to HMRC (60% of £25,140) they’ll be giving you £6,285 (25% Tax Relief top-up on £25,140).
Higher and additional rate self-employed taxpayers get extra tax relief on their pension contributions. You can claim back a further 20% (25% if you’re an additional rate taxpayer) yourself. The best part? This extra relief doesn’t even have to go into your pension.
There is a catch however. Unlike basic rate relief, your pension provider won’t automatically add this to your pension for you. You’ll need to claim it back by adding your pension contributions to a self-assessment tax return. Penfold has got some guidance on claiming higher rate tax relief here.
How the last budget helped
If you’re worried that putting such a big chunk of money into your pension might put you at risk of another tax hit, we’re here to tell you that Chancellor Jeremy Hunt helped with that in the last budget.
If your salary is beyond the £100,000 mark, you might be the kind of earner that can contribute a significant sum into your pension annually. A HMRC stipulation is the amount you can contribute annually before they’ll tax you on it. This is the Annual Allowance.
Previously £40,000, in the last budget the ceiling was raised to £60,000 per annum. You can contribute this amount into your pension without incurring any tax penalties during any tax year (e.g. between 6th April 2023 and 5th April 2024).
And if you’re worried that contributing such large sums into your pension regularly might mean more tax because you’ve exceeded something called the Lifetime Allowance, Mr Hunt had some further good news for you.
Up until April 2023, the absolute most you could put into your private pension without getting taxed on it during your whole working life was £1,073,100. Since 6th April 2023 you will not be taxed on any pension savings above this amount.
As an example, if you’d planned to contribute the maximum amount of your Annual Allowance of £60,000 annually, you could only do it for 18 years – and working lives are usually a lot longer.
If you’re planning on avoiding the 60% tax trap by regularly diverting tens of thousands of pounds into your pension, you’re no longer limited by how much you can contribute over the lifetime of your career. Your only limit is the Annual Allowance of £60,000.
Without a doubt, using your pension is an excellent way to escape the 60% tax trap and may also greatly enhance your retirement savings.
This blog isn't personal advice. The impact of pension and tax rules will depend on individual circumstances, so if you're unsure please seek advice before acting.
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Find more tax guidance
Do you need to complete a tax return? What can you expense? What happens if you have a fluctuating income? Our tax guidance answers these questions and more, to get you in the best shape possible for your tax return and tax year end.
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