What are The Tax Implications of Earning Over £100k?

What are The Tax Implications of Earning Over £100k

Earning more than £100,000 is a tremendous achievement, but it comes with its own set of tax consequences that might exacerbate your financial condition. In this article, we’ll look at how the UK income tax system works, the implications of exceeding the £100,000 level, and how to be tax-efficient when earning a high wage.

Table of Contents

How UK Income Tax Rates Work

The UK tax system is progressive, which means that the higher your income, the higher your tax rate. Here is a detail of the existing income tax brackets for the fiscal year 2024/25:

 

 Income BandTax Rate
Personal AllowanceUp to £12,5700%
Basic Rate£12,571 to £50,27020%
Higher Rate£50,271 to £125,14040%
Additional RateOver £125,14045%

 

What Happens If I Earn Over 100k in the UK?

Reaching an annual income of £100,000 in the UK triggers several significant changes in your tax obligations and financial planning:

  1. Loss of Personal Allowance: Once you begin earning £100,000, you start losing your tax-free Personal Allowance. For every £2 you earn over £100,000, you lose £1 of your tax-free Personal Allowance. This means at an income of £125,140 or above, your Personal Allowance drops to zero, leading to higher taxable income.

  2. Effective 60% Tax Rate: Due to the loss of Personal Allowance, the effective tax rate on earnings between £100,000 and £125,140 is 60%. This is because you are taxed at the higher rate of 40% on your income while also losing £1 of your Personal Allowance for every £2 earned, resulting in an additional 20% tax effect on this portion of your income.

  3. Higher Income Tax Bracket: Income over £100,000 falls into the Higher Rate tax bracket of 40%. This applies to earnings between £50,271 and £150,000 annually. All earnings over £125,140 will be subject to the additional rate of 45%.

  4. Additional Tax Considerations: Individuals earning over £100,000 may face complexities such as adjusting National Insurance contributions and potential impacts on tax credits and benefits.

Example Scenario

To illustrate how these changes impact your taxes, consider the following example:

  • Luke’s Income: £100,000
  • Pay Rise: £500

This extra £500 will be taxed at the higher rate (40%), just like everything else that Luke earns above £50,271. However, for every £2 he earns over £100,000, Luke now loses £1 of his tax-free Personal Allowance. This means that £250 of his Personal Allowance now needs to be taxed at his normal 40% higher rate.

  • Tax Calculation: 40% of £250 is £100, so he will now pay that extra tax on top of the normal 40% higher rate of tax he pays on his earnings above £100,000, which in this case would be £200.

  • Total Tax: All in all, Luke is paying £300 more in tax (£100 + £200) since receiving his £500 pay rise. This equates to 60% of the money he earns above £100,000. While Luke is still technically only in the ‘higher rate’ tax band, he is effectively being taxed on 60% of his earnings above £100,000.

However, this cycle won’t go on forever. Once Luke starts earning £125,140, he will have lost all his Personal Allowance and will begin being taxed at the normal additional rate (45%) for all his earnings above that, with no more Personal Allowance to lose

Example of the 60% Tax Rate

Let’s break down this 60% tax rate with an example:

  • You earn £100,000 and receive a £1,000 pay rise.
  • This extra £1,000 is taxed at the normal 40% Higher Rate.
  • For every £2 you earn over £100,000, you lose £1 of your tax-free Personal Allowance. So, you lose £500 of your Personal Allowance.
  • This £500 is then also taxed at 40%, resulting in an extra £200 tax.
  • In total, you pay £600 tax on the £1,000 pay rise, which is 60%.

Being Tax-Efficient When Earning Over £100,000

There are several strategies to help you reduce your taxable income and avoid the 60% tax trap:

  1. Salary Sacrifice Schemes: Opt for non-cash benefits like a company car or private health insurance instead of a cash pay rise.
  2. Pension Contributions: Increase your pension contributions to reduce your taxable income.
  3. Charitable Donations: Donate to charity and claim Gift Aid tax relief.
  4. Tax-Efficient Investments: Look for investments that offer tax advantages, like ISAs

Filing a Tax Return as a High Earner

Previously, if your income exceeded £100,000, you were required to file a tax return. However, beginning April 2024, this need will be waived for anyone earning up to £150,000 who only receive work or PAYE income. Regardless of this change, you must confirm that your PAYE code is valid to avoid overpaying or underpaying taxes.

Checking Your PAYE Code

Your PAYE code regulates the amount of tax deducted from your salary. If you receive the full Personal Allowance, your standard code is 1257L. If you earn more than £100,000, your tax code should reflect the fall in your Personal Allowance. For example, if you make £105,000, your code should be 1007L.

Steps to Ensure Correct Taxation

  1. Check Your Payslip: Verify that your PAYE code is correct.
  2. Contact HMRC: If your code is wrong, contact HMRC to get it corrected.
  3. Review Your Tax Statements: Ensure that you have paid the right amount of tax. If you find discrepancies, HMRC will send you a calculation once they reconcile your records.

Seeking Professional Advice

Earning over £100,000 brings complicated tax issues. Speaking to tax professionals can help you understand and make the best decisions for your money. These experts can guide you through the tax rules, helping you use all available benefits and handle your taxes properly.

Conclusion

Recognising how taxes impact those earning over £100,000 is vital for making informed financial decisions. By learning about the UK income tax system and looking into ways to save on taxes, you can reduce your tax bill and increase your savings. Always keep your tax code current and think about speaking with a tax expert to help with the complexities of high-income taxes. This will help you manage your finances better now and in the future.

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