If you’re a higher-rate taxpayer, you might fall into a 60% tax bracket without realising it. However, there are several ways to avoid paying more tax than you bargained for, which we’ll discuss in this article.
Let’s jump in with an important question.
What is the 60% tax trap?
The 60% tax rate is an unofficial rate that doesn’t technically exist on paper. However, because tax allowances taper off the more you earn, it becomes incredibly real when the taxman comes knocking.
Who is affected by the 60% tax trap?
This particular tax trap affects people who earn between £100,000 and £125,140 a year.
Why? Because once you earn £100,000 or more, the personal allowance of £12,570 (the amount you earn before paying income tax) reduces. This tapers down to a rate of £1 for every £2 you earn above £100,000.
So, for every £100 of income between £100,000 and £124,240, you are left with £40. This is because £40 is taken as income tax and the other £20 is lost by the reduced personal allowance. This equals an effective 60% tax rate for those earning between these amounts.
Using your pension to beat the 60% tax trap
It sounds pretty daunting, doesn’t it? But not to worry. Here’s how you can reduce your taxable income using your pension.
Top up your pension to reduce tax
The quickest and easiest way to reduce your taxable income is to pay more into your pension before the end of the tax year. Doing so can take you below the relevant threshold and not only will you reduce your income tax bill, but you’ll also top up your retirement fund.
This makes it a win/win situation and helps you maximise your wealth in the long term to achieve your long-term goals.
Any contribution you make to your pension means your taxable income is reduced, but bear in mind that you can only pay up to £60,000 into your pension each year whilst enjoying tax relief.
Reduce your tax liability with child benefit
High-income child benefit is for families where one partner has an adjusted net income of £60,000 or more and one of you receives child benefit. If this applies, whichever one of you earns the most will have to pay a portion of it back in extra income tax.
In terms of repayment amounts, it’ll be 1% of your child benefit for every extra £100 you earn above £60,000 each.
To get around this and reduce your tax bill, contribute more to your pension to bring you back into a lower tax band and avoid paying child benefit altogether.
Conclusion
Tax matters are complex which is why so many people get caught out. However, there are many options available for those looking to mitigate their tax liabilities and plan properly for their future and the future of their loved ones.
At Cedar House Financial, we have extensive experience in helping our clients with tax mitigation and can do the same for you. With retirement planning built around your requirements and goals and wealth management to help you maximise your assets, call our experts on 020 8366 4400 or email enquiries@cedarhfs.co.uk