The 60% Tax Trap: Why High Earners Pay More Than They Think

If you earn between £100,000 and £125,140, you face what's known as the "60% tax trap" - a hidden tax rate that can catch high earners off guard. This isn't an official tax rate, but rather the effective rate you pay due to the gradual withdrawal of your personal allowance.

Why It's Called the 60% Tax Trap

For every £2 you earn above £100,000, you lose £1 of your personal allowance. This means you're effectively paying 40% tax on the additional income, plus 40% tax on the £1 of personal allowance you've lost - resulting in a total effective tax rate of 60% on income between £100,000 and £125,140.

- On £110,000, you're £10,000 over the threshold
- This results in the loss of £5,000 of your personal allowance
- That £5,000, which would have been tax-free, is now taxed at 40% = £2,000
- The £10,000 of extra income (from £100k to £110k) is also taxed at 40% = £4,000

Total tax on this £10,000 slice:
£2,000 (lost allowance) + £4,000 (income tax) = £6,000

Effective tax rate on this portion:
£6,000 ÷ £10,000 = 60%
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Including National Insurance: Effective Marginal Rate ~62%

The situation becomes even more punitive when you consider National Insurance contributions. All earnings in this £100k–£125,140 band are above the Upper Earnings Limit (UEL) for employee Class 1 National Insurance, so they also attract 2% NI.

- 40% Income Tax on additional earnings
- 20% additional tax from lost personal allowance
- 2% National Insurance on earnings above UEL

Total effective marginal rate: 40% + 20% + 2% = 62%
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Loss of Personal Allowance

Your personal allowance of £12,570 (2024/25) is gradually reduced by £1 for every £2 of income above £100,000. Once your income reaches £125,140, you lose your entire personal allowance. This means:

- At £100,000: Full personal allowance of £12,570
- At £110,000: Personal allowance reduced to £7,570
- At £125,140: No personal allowance remaining

Impact on Free Childcare

Crossing the £100,000 income threshold can significantly affect the financial support available to working parents, especially those with children in nursery. Two major government childcare benefits are lost once either parent earns over £100,000:

1. Tax-Free Childcare Account – Worth up to £2,000 per child per year

The government tops up your childcare account by 20% (i.e. £2 for every £8 you pay), up to:
- £2,000 per child per year
- £4,000 per year for a disabled child

2. 30 Hours Free Childcare for Working Parents – Worth £6,000–£8,000 per year

Eligible working parents of 3–4-year-olds get:
- 30 hours of free childcare per week
- For 38 weeks per year (term-time only)

Important: Both benefits are immediately lost once either parent earns more than £100,000, regardless of household income.

This makes it crucial to consider whether salary increases above £100,000 are truly beneficial for families with young children – the combined loss can exceed £10,000 per year.
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Practical Steps to Avoid the Tax Trap

Fortunately, there are several legitimate strategies to reduce your taxable income and avoid or minimise the 60% tax trap:

1. Maximise Pension Contributions

Contributing to your pension is one of the most effective ways to reduce taxable income. You can contribute up to £60,000 annually (2024/25) or 100% of your earnings, whichever is lower. Pension contributions receive tax relief at your marginal rate, effectively reducing your taxable income pound-for-pound.

2. Enterprise Investment Scheme (EIS)

EIS investments allow you to invest up to £1 million annually in qualifying companies and receive 30% tax relief. This means a £10,000 investment costs you only £7,000 after tax relief, while also reducing your taxable income.

3. Seed Enterprise Investment Scheme (SEIS)

SEIS offers even more generous tax relief at 50% on investments up to £200,000 annually. A £10,000 SEIS investment costs you only £5,000 after tax relief, making it highly attractive for high earners.

4. Other Strategies

- Salary sacrifice schemes (cycle to work, electric cars, additional pension contributions)
- Making charitable donations through Gift Aid
- Timing of bonuses and income to spread across tax years
- Consider incorporation if you're a contractor or freelancer

Key Takeaway

The 60% tax trap is avoidable with proper planning. By using pension contributions, EIS/SEIS investments, and other tax-efficient strategies, you can significantly reduce your effective tax rate and keep more of your hard-earned income.

Disclaimer: This article is for informational purposes only and should not be considered personalised tax advice. Always consult with a qualified tax advisor or financial planner before making significant financial decisions.