Joining the 6 figure salary club?
Your hard work has paid off and you are embracing joining the 6 figure salary club. It’s a coveted club with a small percentage of the UK workforce able to claim membership.
A cause for celebration? You’d think so. There’s just a fairly major tax issue you need to be aware of. Individuals earning between £100,000 and £125,140 are subject to a whopping 60% effective tax rate.
On a positive note, there are ways to mitigate against this tax grab.
60% effective tax rate
So how does the 60% effective tax rate work, given that the highest tax band rate is 45%?
Once you earn above £100,000 you lose £1 of your personal allowance for every £2 you earn. The annual personal allowance lets UK individuals earn up to £12,540 tax-free. When your earnings reach £125,140, you lose the full personal allowance.
Once your earnings are above £100,000 you pay 20% tax on the amount of the lost personal allowance. On earnings of £125,140 the tax is £2,514 a year. You also pay tax at 40% on all income above £37,700 a year. Individuals earning under £100,000 a year pay tax of 40% on income over £50,270. So, not only do you lose part or all of your personal allowance, but you also pay 40% tax on income over £37,700 rather than on income over £50,270. Income over £125,140 incurs tax of 45% as this falls in the additional rate tax band.
Calculating your adjusted personal allowance
Calculating your adjusted personal allowance once your earnings exceed £100,000 is fairly straightforward. Divide the income above £100,000 by 2 and deduct this amount from £12,570. For example, someone earning £110,000 will have a reduced personal allowance of £7,570. (£12,570 – £5,000).
Tax calculations for 6 figure incomes
The tax calculations below illustrate the impact of the reduction and loss of the personal allowance on 6 figure incomes.
| Tax bands | £100,000 | Tax | £120,000 | Tax |
|---|---|---|---|---|
| 0% | £12,570 (PA) | 0 | £2,570 (PA) | 0% |
| 20% | £37,700 | £7,540 | £37,700 | £7,540 |
| 40% | £49,730 | £19,892 | £79,730 | £31,892 |
| Total | £100,000 | £27,432 | £120,000 | £39,432 |
In the above examples, someone earning £120,000 a year pays £12,000 more tax than someone earning £100,000. This equates to an effective tax charge of 60% of the additional £20,000 of income.
Tactics to avoid the 60% effective tax rate
Thankfully there are some tactics to avoid the 60% effective tax rate. Speak to your employer about salary sacrifice schemes that are available to employees. Making use of a salary sacrifice scheme can reduce your tax liability.
Salary sacrifice
Salary sacrifice is where employees reduce their pay in exchange for a non-cash benefit provided by their employer. The employee gives up or sacrifices part of their pay in exchange for a benefit such as a pension contribution.
In the earlier example, if the employer contributes £20,000 of the £120,000 salary into a pension as a salary sacrifice this saves the employee £12,000 in tax. They will also save £400 in employee national insurance contributions and the employer £2,760 in employer contributions. The savings from salary sacrifice benefit both employees and employers.
To learn more about the options and benefits of salary sacrifice, read the following article published by The Guardian:
