Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

You’ll find no mention of it in the statute books but Britain’s tax regime imposes a tax rate of 60% on people whose income exceeds £100,000 a year. 

Many may have no inkling of this tax band until they find themselves caught by it; some may even remain unaware of it when they are paying it – especially if their salary is less than £100,000 but a bonus boosts their total income beyond that figure. 

If so, they will also be unaware that this 60% tax is easily and legally avoided by paying more into a pension. If necessary, you can use pension contributions not only for the current year but from the three previous ones too. 

Here we explain what this 60% tax is and how to avoid it. If you face being caught by it, remember to act before the end of the tax year on 5 April. 

I thought the top rate of tax was 45%. How come I could pay 60%? 

You can thank the crazy complexity of Britain’s tax system. It’s true that the highest income tax band is 45%, which applies to income of more than £125,140. However, there is effectively a 60% band between £100,000 and £125,140. This is because, once you reach £100,000, each extra pound of income results in the loss of 50p of your tax-free personal allowance, which is the first £12,570 of your income. These figures are for England, Wales and Northern Ireland; in Scotland the effective rate is not 60% but 67.5%, as we’ll explain in a moment.

The reason for the effective 60% rate is actually rather subtle. What happens is that the shrinking personal allowance drags down the threshold for higher-rate tax by a similar amount (while it’s commonly said that this year’s threshold for 40% tax is £50,271, this is true only for those who receive the normal personal allowance of £12,570; in fact the 40% threshold is £37,700 plus the personal allowance and the basic-rate band is always £37,700 wide).

So when, as someone whose salary is £100,000, you earn one extra pound, your own higher-rate band is widened at both ends: at the top because you’ve earned that extra £1, and at the bottom because the shrinkage of the personal allowance drags the threshold down. It’s wider at the top by £1 and at the bottom by 50p; if you tax £1.50 at 40% you get 60p. As your before-tax income went up by only £1 in the first place and your tax bill is 60p more, your effective tax rate is 60%.

In passing we might note that it’s just as well the personal allowance is not withdrawn at a rate of £1 for every extra £1 in income above £100,000. That would widen your higher-rate band by £1 at the top and £1 and the bottom; 40% tax on £2 is 80p, so the effective tax rate on the extra £1 of income would be 80%. Shrinking the personal allowance by £1.50 for every extra £1 in income would result in an effective tax rate of 100% (40% of £2.50 is £1).

Scotland has a plethora of tax rates but a similar principle applies. All tax thresholds are dragged down by the erosion of the personal allowance and the amount in pounds that each person pays in tax for each of these bands is the same (as long as their earnings cover each band in full). None of that changes when someone who earns more than £100,000 earns an extra £1. All that changes is how much of their income is subject to the rate that applies at £100,000, which in Scotland is 45%. Each £1 in extra income here widens that tax band by £1.50, as in the rest of the country, so the extra tax is 45% of £1.50, or 67.5p, an effective tax rate of 67.5%.

To such sky-high tax rates we can add 2% in National Insurance, so the final deduction from your pay packet comes to 62% (in England, Wales and Northern Ireland) or 69.5% (in Scotland).

Incidentally, it’s also at £100,000 a year that parents lose entitlement to 30 hours a week of free childcare, so there is even more reason to bring your taxable income down below that figure by making pension contributions.

In all parts of the UK the 60% or 67.5% band ends at £125,140. At this point, the £25,140 in earnings over £100,000 is enough to wipe out your personal allowance entirely. Above £125,140, the effective rate of tax on each extra £1 of income reverts to 40% in England, Wales and Northern Ireland (in Scotland a 48% band starts at £125,140).

This does not mean, of course, that you can give a sigh of relief and forget about it in the knowledge that your marginal tax rate is ‘only’ 45% (or 48% in Scotland): you have still lost all your personal allowance, not to mention your childcare entitlement. We’ll now explain how you can get both of them back.

What is this legal way to avoid the 60% tax?

In a word: by making pension contributions. Paying money into a pension reduces your effective taxable income and, if your pension contributions reduce your taxable income to less than £100,000, your personal allowance will be restored in full.

The principle is simple, the nuts and bolts less so. Let’s say you earn £110,000 and want to bring your taxable income back to £100,000 exactly to extricate yourself from the 60% tax band. You might imagine that you have to write a cheque for £10,000 to a pension company but in fact £8,000 will suffice. This is because the pension company will automatically top up your contribution by £2,000, which represents basic-rate tax relief from HMRC. So, the amount that ends up in your pension once that tax relief is credited to your account is £10,000.

You’ll need to fill in a tax return too because that’s how you claim the rest of the tax relief you are due, which will be paid directly to you as a refund by HMRC. The tax office will compare the tax you are actually liable for with what you have already paid and refund the difference, so the extra you paid, thanks to the 60% rate, will be accounted for automatically.

The method of making pension contributions described above applies to non-employment schemes. For employment or workplace schemes the situation is different and you should check what to do with your company or its pension scheme.

And how does using previous years’ pension allowances work?

Taxpayers are allowed to make pension contributions not just from their annual allowance for the current tax year but with those of the three previous ones too, as long as they have unused pension allowance from those years and meet a couple of other conditions. This is known as the ‘carry forward’ scheme.

This means that someone who earns £200,000 could reduce this year’s taxable salary all the way down to £100,000 and therefore have their full personal allowance restored and avoid the 60% tax trap in its entirety (as well as the 45% tax band and the loss of childcare).

To do so, they would first make an £80,000 contribution to their pension, knowing that HMRC will top it up to £100,000 thanks to basic-rate tax relief (for a non-workplace pension). On their tax return for this tax year, they would state that they are paying £100,000 into their pension (using this year’s full £60,000 annual allowance plus £40,000 from an earlier year). The earliest tax year they can use is 2021-22 and, if in that year they have £40,000 of unused pension allowance, they must use it all, rather than any unused allowance from a more recent tax year.

Those with very high incomes need to watch out for a rule under which their annual allowance for pension contributions is reduced. Known as the ‘taper’, it cuts your annual allowance in steps of £5,000 once your annual income exceeds £260,000, until the minimum allowance of £10,000 a year is reached at £360,000. The rules are extremely complex but, in summary, if you think you have earned more than £260,000 in this tax year, or earned more than £240,000 in any of the three previous tax years, you could be caught by the taper. You can read more about this in our guide to the ‘tapered’ annual allowance. Alternatively, in view of the potential savings and the potential costs of making a mistake, it may be worth seeking help from a qualified financial adviser, either from Fidelity or elsewhere.

No matter what your salary, if you want to use unused annual allowance from previous years you must have earned enough in the current tax year to cover the entire contribution and you must have been a member of a pension scheme in every previous year you want to use, even if you did not make any contributions in those years.

Fidelity has published a guide to the carry forward scheme and there is also a tool that can help you work out if you have unused annual allowance on the government’s website.

Note that the use of previous years’ pension allowances does not allow you to avoid the 60% tax band in those years, if you were caught by it; they can help you avoid it only in the current tax year.

It’s not necessary to advise HMRC if you’re using previous years’ pension allowances, although it would be sensible to keep records in case of any queries from the taxman in the future.  

If you’ve got pensions spread across different providers, moving them to Fidelity’s Self-Invested Personal Pension (SIPP) could help you take control and get your money working harder. Plus, get £150 to £1,500 cashback. Exclusions, T&Cs apply.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). Please note that these guidance tools are not a personal recommendation in respect of a particular investment. If you need additional help, please speak to an authorised financial adviser.  You should regularly reassess the suitability of your investments to ensure they continue to meet your attitude to risk and investment goals. It’s important to understand that pension transfers are a complex area and may not be suitable for everyone. Before going ahead with a pension transfer, we strongly recommend that you undertake a full comparison of the benefits, charges and features offered. To find out what else you should consider before transferring, please read our transfer factsheet. If you are in any doubt whether or not a pension transfer is suitable for your circumstances or you are unsure about the suitability of an investment we strongly recommend that you seek advice from one of Fidelity’s advisers or an authorised financial adviser of your choice. 

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