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60% Effective Tax Rate
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UK’s 60% effective tax rate
You may have heard of the UK’s 60% effective tax rate in media articles. This high percentage of effective tax catches people with annual income between £100,000 and £125,140. While these earnings fall within the 40% higher rate tax band, the 60% effective tax rate results from a gradual reduction in the personal allowance.
Personal allowance
UK individuals have an annual tax-free allowance of £12,570 allowing them to earn this amount before paying any tax.
However, once your annual income exceeds £100,000 you lose £1 of your personal allowance for every £2 you earn over £100,000. You lose the personal allowance in full when your income reaches £125,140.
Someone with an annual income of £115,000, will have a reduced personal allowance of £5,070. To calculate the new personal allowance divide £15,000 by 2, then deduct the amount of £7,500 from £12,570. Losing £7,500 of your personal allowance, means you pay an extra 40% of tax on this amount of your income, which is £3,000. Tax of 40% is also payable on the £15,000 which is £6,000. Jointly this amounts to a tax bill of £9,000 which is an effective tax rate of 60% on £15,000.
Tax bands for individuals earning over £125,140
The chart below illustrates the tax rates and tax bands for individuals earning over £125,141 without a personal allowance.
| Band | Tax rate | Income |
|---|---|---|
| Basic rate | 20% | Up to £37,700 |
| Higher rate | 40% | £37,701 to £125,140 |
| Additional rate | 45% | Over £125,141 |
Tax impact of losing part or all of the personal allowance
The calculations below illustrate the tax impact of losing part or all of the personal allowance. The figures show the tax payable on annual of income £100,000 with the full personal allowance (PA) of £12,570 compared with the tax due on £115,000 with a reduced personal allowance of £5,070.
| Tax bands | £100,000 | Tax | £115,000 | Tax |
|---|---|---|---|---|
| 0% | £12,570 (PA) | 0 | £5,070 (PA) | 0 |
| 20% | £37,700 | £7,540 | £37,700 | £7,540 |
| 40% | £49,730 | £19,892 | £72,230 | £28,892 |
| Total | £100,000 | £27,432 | £115,000 | £36,432 |
In this example, someone earning £115,000 a year pays £9,000 more in tax than someone earning £100,000. The reduction of £7,500 in the personal allowance delivers an additional tax charge of £3,000. Adding this to the 40% tax liability of £6,000 on the extra £15,000 of income results in a total tax bill of £9,000. This is an effective tax rate of 60% on the extra £15,000 of income.
| Tax bands | £100,000 | Tax | £125,140 | Tax |
|---|---|---|---|---|
| 0% | £12,570 (PA) | 0 | 0 (PA) | 0 |
| 20% | £37,700 | £7,540 | £37,700 | £7,540 |
| 40% | £49,730 | £19,892 | £87,440 | £34,976 |
| Total | £100,000 | £27,432 | £125,140 | £42,516 |
In the above example, someone earning £125,140 pays £15,084 more in tax than someone earning £100,000. Losing the full personal allowance means the effective tax rate on the additional £25,140 of income is 60%.
Getting around the 60% tax
There are ways of getting around the 60% tax rate on earnings between £100,000 and £125,140. Using a salary sacrifice scheme is an effective option to mitigate against the extra tax charge and frozen tax rate bands.
Salary sacrifice
Salary sacrifice is an arrangement where an employee reduces their pay in exchange for a benefit provided by their employer. The employee gives up part of their gross pay for a benefit such as pension contributions or access to a bike scheme. There are several salary sacrifice benefits employers can offer their staff. By reducing their pay, employees save on income tax and national insurance contributions.
To read more about the tax benefits from salary sacrifice, take a look at this in-depth article recently published by the Guardian:
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