HM Revenue & Customs (HMRC) has significantly updated its projections regarding the number of taxpayers expected to enter the 60% income tax bracket within the next four years, revising the figure to over 2 million, which is an increase of 260,000 from previous estimates.

Despite the highest income tax rate being 45%, applicable to earnings exceeding £125,140 annually, a particular aspect of the tax framework leads to a marginal tax rate of 60% for those earning between £100,000 and this threshold.

This situation arises because for every £2 earned above £100,000, £1 of the £12,570 personal tax-free allowance is lost, ultimately impacting those earning £125,140. When considering the 2% national insurance levy, individuals with earnings over £100,000 lose 62p in tax for every additional £1 earned.

In May, HMRC forecasted that 1.74 million workers would lose part or all of their personal allowance by 2029. The revised estimate now stands at 2.08 million, as indicated by data from wealth manager NFU Mutual.

What’s Behind the Increase?

The rise in taxpayers facing a 60% tax rate can be attributed to the freezing of income tax thresholds until 2028. This freeze means that as wages increase, more individuals will inadvertently fall into higher tax brackets, a phenomenon known as fiscal drag.

By next April, HMRC anticipates that 1.66 million higher earners will find themselves trapped within the 60% tax threshold, comprising 657,000 losing some of their personal allowance and over one million losing the entirety of theirs.

By the conclusion of the 2027-28 tax year, it is projected that 747,000 individuals will have lost some personal allowance while a staggering 1.23 million will lose it completely, culminating in 1.98 million taxpayers impacted overall.

Sean McCann from NFU Mutual commented, “The figures underscore the growing toll of fiscal drag. The threshold at which the personal allowance begins to decrease has remained unchanged since 2010. Had the additional rate threshold risen in line with inflation, it would currently be £149,000.”

HMRC’s updated figures align with wage growth forecasts provided by the Office for Budget Responsibility.

The Prolonged freeze

The £12,570 threshold for initiating basic 20% tax and the £50,270 40% tax threshold have remained stagnant since 2021. It is anticipated that this freeze will generate £1.2 billion for the Treasury by 2028.

Shaun Moore from Quilter remarked, “The tax trap between £100,000 and £125,140 is among the most severe thresholds in the tax system. While it’s certainly a privilege to earn at this level, it can also deter professionals from pursuing higher-paying positions.”

Parents whose salaries exceed £100,000 might face even greater disadvantages, as income above this threshold results in the loss of tax-free childcare benefits and part of the 30 hours per week of free childcare available for three and four-year-olds.

There is a push from various quarters for the government to address the £100,000 income cliff. The campaign, initiated last November, advocates for tax thresholds to be indexed to inflation in order to prevent more individuals, including retirees and public sector professionals like nurses and teachers, from being pushed into higher tax brackets.

During the 1991-92 tax year, only 3.5% of taxpayers, approximately 1.6 million individuals, paid the top income tax rate of 40%. By the 2027-28 tax year, it is expected that about 14% of taxpayers, or 7.8 million, will be subject to the 40% rate, including one in eight nurses and one in four teachers, according to estimates from the Institute for Fiscal Studies (IFS). Additionally, the Office for Budget Responsibility has indicated that around 500,000 more individuals will fall under the additional rate.

The “personal allowance taper,” which begins at the £100,000 threshold, was introduced in 2010 by Labour Chancellor Alistair Darling as a revenue-raising measure following the global financial crisis, alongside the additional tax rate of 50%, which was subsequently reduced to 45% in 2013 where it remains.

Strategies to Avoid the Tax Trap

You can determine your risk of entering the 60% tax trap by calculating your total income from various sources, including employment, self-employment, pensions, investments, and rental income, to see if your adjusted net income exceeds the £100,000 mark.

There are effective strategies to lower your adjusted net income and evade the 60% tax rate. One such strategy is to increase your pension contributions.

For instance, if your taxable income is £107,000, the last £7,000 will incur a 60% tax rate. However, if you contribute £7,000 to your pension pre-tax, you retain your £12,570 personal allowance, resulting in a cost of just £2,800 and a tax saving of £4,200.

Helen Morrissey from Hargreaves Lansdown noted that contributing to a pension is particularly beneficial for those whose income is just above the additional rate tax threshold: “Every £2 of income you bring below £125,140 not only avoids the highest tax rate but also recovers £1 of your personal allowance, yielding a significant dual advantage.”

Additionally, charitable giving can lower your adjusted net income. Utilizing Gift Aid allows charities to reclaim 25p for every £1 donated, thereby reducing your net income by £1.25 for every £1 given. For example, if you earn £125,140 and donate £20,112, the charity benefits from £5,028 in tax relief, boosting your gift to £25,140. You could subsequently reclaim the £5,028 through your tax return, making your effective cost £15,084 and bringing your adjusted net income back to £100,000, reinstating your personal tax allowance, thus saving you significant tax costs, according to Blick Rothenberg.

For self-employed individuals or business owners, strategic planning of income timing may yield benefits, such as deferring some income to a subsequent tax year. If a share of your income stems from savings interest, consider utilizing an ISA, as earnings from these accounts do not contribute to taxable income. You can save up to £20,000 in ISAs each tax year.

If you are married or in a civil partnership, transfer taxable investments and savings to a spouse who pays a lower rate of tax to maximize their allowances. A basic-rate taxpayer can earn up to £1,000 in interest tax-free (compared to £500 for higher-rate taxpayers), and tax on dividends remains chargeable only after earning £2,000.

For parents with young children, it may be advantageous to adjust earning levels to remain below the £100,000 income threshold. Robert Salter from Blick Rothenberg suggested that some have opted to increase their leave or reduce working hours to lower their salaries and retain access to free childcare.

The Treasury has been contacted for comments.