Insights
The 62% tax trap
For high earners in the UK, crossing the £100,000 income threshold for the first time can bring some unwelcome surprises.
This can include:
- a dramatic jump in the effective rate of tax to 62%,
- the requirement to complete a tax return, and,
- if you have young children, the removal of some benefits related to childcare.
In this article, we’ll break down how this 62% tax rate works, what it means for you, and how pension contributions can offer a powerful way to reduce your tax bill while boosting your long-term financial security.
The Loss of the Personal Allowance
In the UK, every individual is entitled to a personal allowance — the amount of income you can earn tax-free each year. For the 2025/26 tax year, the personal allowance is £12,570.
This allowance is gradually reduced once your income exceeds £100,000. You lose £1 of your personal allowance for every £2 you earn over £100,000. By the time your income reaches £125,140, your entire personal allowance is gone.
This tapering of the personal allowance creates a band of income from £100,000 to £125,140, where the marginal tax rate is effectively 62%. This is because you will pay your normal 40% income tax and 2% national insurance, but the impact of losing the personal allowance is effectively an extra 20% income tax.
This means for someone earning £110,000, they will only receive around £3,800 after tax from their last £10,000 of income!
What could you do to mitigate this?
One of the most effective ways to mitigate this high rate of tax is by making contributions to a pension. For that individual earning £110,000 they have a choice. They could choose to pay the tax and have an extra £3,800 in their bank account over the year. Alternatively, they could choose to pay roughly £10,000 into their pension pay no tax on it but forgo the £3,800 in their pocket today. A trade-off between money today and money later and a big tax incentive to opt for the money later option.
There are various ways of making the pension contribution and the most effective route depends on your circumstances and what your employer offers. There are also some restrictions on the total amount you can pay into pension each tax year. We recommend taking advice before paying big chunks of money into your pension unless you are completely comfortable with what you are doing. Another point to note about pension saving is that you cannot access the money until your ‘minimum pension age’ which is currently 55 but will increase to 57 on 6th April 2028.
A second way of having a tax saving impact is making charitable donations. This doesn’t have the same effect on your long-term financial security but might be something which you want to do.
What if I have children?
For people with young children, the £100,000 income level can be even more of a cliff edge. This is because earning above this threshold can immediately impact your eligibility for Tax Free Childcare and free hours of childcare funding. Making pension contributions or charitable donations can help mitigate the loss of these allowances too.
n.b. The tax rates in this article assume that income is from employment rather than other forms of income such as dividends, rental income or interest. Similar principles can apply to income from other sources but the tax rates are different.
Need help with pension planning or tax mitigation strategies?
We recommend you take advice about this if you are in this position.
At Path Financial, we are Chartered Financial Planners and specialists in ethical and impact investing.
If you would like to book a free consultation with us to discuss investing and your wider financial plan, including tax planning, get in touch:
RISK WARNING
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.