Explaining the 60% income tax rate in the UK

Taxes, taxes, taxes! Just when you thought you had a handle on the income tax system in the UK, along comes a sneaky 60% tax rate lurking in the shadows, ready to surprise unsuspecting high earners. We'll dive into the nitty-gritty of how this 60% income tax rate works, who it affects, and how to tame this taxation beast.

In the 2022/23 financial year, UK taxpayers generally have access to a tax-free personal allowance of £12,570. However, when your annual income goes above £100,000, this allowance gradually reduces. While you are stilled taxed and the higher rate tax threshold for any pound you earn above £100,000, you also get hit by a decreasing tax-free personal allowance. As a result, the effective tax rate can reach up to 60%.

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How does the 60% income tax rate work?

Picture our friend Mike, who made £120,000 during the 2022/23 financial year. Because he's earned £20,000 above the £100,000 limit, his personal allowance takes a £10,000 hit, dwindling down to just £2,570.

So, what does this mean for Mike's taxes? Well, on the £20,000 income over the £100,000 line, he needs to pay £8,000 of Income Tax on the higher tax rate (40%). On top of that he needs to pay £4,000 in incremental tax thanks to his reduced personal allowance. This means that suddenly Mike's looking at a hefty £12,000 tax bill on the £20,000 he's earned above the £100,000 thresholds. That's a whopping 60% effective tax rate.

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What to do if you are at the 60% income tax band?

If you find yourself in a similar position due to receiving end-of-year bonuses or fluctuating profits as a trader, there are a few tax-efficient methods you can consider to alleviate the impact of the 60% tax rate.

1. Contribute to a personal pension: Self-Invested Personal Pensions (SIPPs) contributions, excluding salary sacrifice or employer contributions, can help balance the decrease in the higher rate threshold by increasing the basic rate band by 20% of the grossed-up amount.
2. Donate through Gift Aid: Like pension contributions, the basic rate band extends by 20% of the grossed-up contributions when you make charitable donations using Gift Aid.

It's essential to remember that both of these strategies require available funds. So, evaluate your financial situation carefully before employing these methods to lessen the impact of the 60% tax band.

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While most taxpayers in the UK benefit from a tax-free personal allowance, those with an annual income exceeding £100,000 may face a higher effective tax rate due to the reduction of this allowance. However, there are tax-efficient strategies, such as contributing to a personal pension or donating through Gift Aid, that can help mitigate the effects of the 60% tax rate.