You may have great investment and financial opportunities if you are a high-earner. This could lead to financial difficulties, particularly in terms of the growth of your wealth or the amount of taxes you pay.
To build a solid financial plan and decrease your tax burden, it is always advisable to seek expert financial planning advice.
We’ll show you how to avoid the 60% tax trap in this article.
Continue reading to learn more.
How does the 60% tax trap get you out of it?
You need to first understand the income tax rates in England and Wales.
Personal Allowance — Taxable income up to PS12,000. = 0% tax
Basic Rate — Taxable Income of PS12,571 to PlayStation50,270 = 20% Tax Rate
Higher Rate — Taxable income from PS50,271 up to PS150,000 = 40 percent tax rate
Additional rate – taxable income above PS150,000 is subject to a 45% tax
If your taxable income is more than PS125,140, a Personal Allowance will not be available. Your Personal Allowance will be gradually reduced by PS1 for each additional PS2 of income when your taxable income exceeds PS100,000.
If you earn more than PS100,000.000 and receive a bonus of PS1,000, it would be subject to 40% tax, which will result in you paying PS400 in income taxes.
This bonus would also push you above the PS100,000. You will lose PS500 of your tax-free Personal Allowance. PS500 of your income will now be subject to the 40% tax, which will cost you another PS200.
The 60% tax trap would have made you pay 60% income tax and your PS1,000 bonus would have been taxed at a rate of 60%. This would have left you with only PS400.
There is a way around this tax problem with smart financial planning and simply by using your pension.
How to avoid the 60% Tax Trap with your Pension?
Although the 60% tax trap can be devastating, careful planning can help you reduce your taxable income, and allow you to reclaim your personal allowance, which is tax-free.
You can do this by contributing to your state pension. If you earned PS125,140, for example, you would have lost all of your tax-free Personal Allowance. You could, however, decide to contribute PS20,112.
Your pension contributions can be used to get tax relief. Therefore, the government will provide PS5,028 basic rate tax relief for this contribution. This relief is directly paid into your pension pot, bringing your total contribution up to PS25.140. Additional PS5,028 may be claimed as higher-rate tax relief.
Your taxable income will be reduced by PS25 140 as a result of your contribution. Your taxable earnings will now be PS100,000. You’ll get your PS12570 personal allowance, which is tax-free. You will also save another PS5,028 on tax.
You will not only avoid the 60% tax trap by contributing your pension fund, but you’ll also see a total benefit in this instance of PS15.084.
You can also save National Insurance if your pension contributions are made by salary sacrifice. This will increase the total benefit.
It’s important to choose the right financial advisor to help you rebuild your finances and avoid the 60% tax trap.