HM Revenue & Customs (HMRC) has made significant adjustments to its forecast regarding the number of taxpayers subject to a 60% income tax rate, estimating that over two million individuals will fall into this category within the next four years.

Although the highest income tax rate stands at 45%, which applies to income exceeding £125,140 a year, an anomaly in the tax system means that earnings between £100,000 and the additional rate threshold encounter a marginal tax rate of 60%. This occurs because for every £2 earned above the £100,000 mark, taxpayers lose £1 of their personal tax-free allowance of £12,570, which is fully depleted for those earning £125,140 or more. Including the 2% national insurance contribution, individuals earning above £100,000 effectively give up 62p of every additional pound they earn.

In May, HMRC expected approximately 1.74 million workers to be impacted by the loss of part or all of their personal allowance by the year 2029. This figure has now surged to an anticipated 2.08 million, as reported by the wealth management firm NFU Mutual.

Factors Behind the Increase

The increase in taxpayers facing the 60% income tax rate is attributed to the freezing of income tax thresholds until 2028. This freeze leads to a phenomenon known as fiscal drag, whereby rising wages push more individuals into higher tax brackets.

By April next year, HMRC projects that 1.66 million higher earners will be ensnared in the 60% tax trap—this includes 657,000 who will lose some of their personal allowance, and one million who will lose it entirely.

By the end of the 2027-28 tax year, it is forecasted that 747,000 individuals will have lost some personal allowance, while 1.23 million will have completely lost it, amounting to a total of 1.98 million taxpayers impacted.

Sean McCann of NFU Mutual commented, “These figures illustrate the growing ramifications of fiscal drag. The threshold where personal allowance reduction begins has remained unchanged since 2010. If it had been adjusted for inflation using the consumer prices index, it would currently be £149,000.”

HMRC updated its projections in response to wage growth assumptions from the Office for Budget Responsibility.

The Ongoing Freeze

The thresholds for basic 20% tax at £12,570 and 40% tax at £50,270 have remained frozen since 2021, a measure expected to generate £1.2 billion for the Treasury by 2028.

Shaun Moore from Quilter remarked, “The tax burden between £100,000 and £125,140 ranks among the most severe within the system. While it may be considered a fortunate dilemma to have, it can discourage people from pursuing higher salaries or increased workloads out of fear of falling into this tax trap.”

Parents experiencing salary increases that push their income beyond £100,000 may find themselves in an even more precarious situation. This is because exceeding this threshold can result in losing access to tax-free childcare and 15 out of the 30 hours of free childcare available for three and four-year-olds.

There is a push for the government to address the £100,000 threshold dilemma and adjust tax thresholds to reflect inflation to prevent more individuals, including retirees and public sector employees like teachers and nurses, from entering higher tax brackets.

In the 1991-92 tax year, only 3.5% of taxpayers—around 1.6 million—were subject to the highest income tax rate of 40%. Estimates indicate that by the 2027-28 tax year, 14% of taxpayers (approximately 7.8 million) will pay the 40% rate, including one in eight nurses and one in four teachers, as projected by the Institute for Fiscal Studies (IFS). Furthermore, about 500,000 additional taxpayers are anticipated to enter the higher tax bracket, as per the Office for Budget Responsibility.

The “personal allowance taper,” which begins at the £100,000 threshold, was enacted in 2010 by then Labour Chancellor Alistair Darling to generate additional revenue following the global financial crisis. He also introduced the additional tax rate of 50%, subsequently reduced to 45% in 2013, where it has remained.

Strategies to Avoid the Tax Trap

To determine if you might be affected by the 60% tax rate, calculate your total income from employment, self-employment, pensions, rental income, investments, and other sources to see if your adjusted net income exceeds £100,000.

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

For instance, if your taxable income is £107,000, the last £7,000 would be taxed at a 60% rate. However, by making a pre-tax pension contribution of £7,000, you could maintain your full personal allowance of £12,570. This pension contribution would essentially cost you £2,800 while saving £4,200 in tax.

Helen Morrissey from Hargreaves Lansdown noted that additional pension contributions also benefit those whose income just crosses the additional rate tax threshold: “For every £2 of income brought below £125,140, you not only avoid the highest tax rate but also regain £1 of your personal allowance, creating a significant double advantage.”

Charitable donations are another avenue. Contributions made through Gift Aid diminish your adjusted net income; under this scheme, charities can reclaim an extra 25p for every £1 donated. Each £1 you donate effectively reduces your adjusted net income by £1.25.

For example, if you earned £125,140 and donated £20,112 to a charity, the organization would gain an extra £5,028 in tax relief, bringing the total impact of your donation to £25,140. You could then recover that £5,028 through a tax declaration. Consequently, this £25,140 charity contribution would cost you £15,084 while bringing your adjusted net income down to £100,000, fully restoring your personal allowance of £12,570, resulting in a total tax saving of £15,084, as per Blick Rothenberg.

If you are self-employed or run a business, strategically planning the timing and structuring of your income might yield benefits. Deferring some income into the following tax year could be advantageous. If part of your income comes from interest on savings, utilizing an ISA can protect your funds. Income generated from shares or cash in these accounts is not subject to income tax. You can save up to £20,000 in ISAs each tax year.

If married or in a civil partnership, consider allocating taxable investments and savings to your lower-tax-rate spouse to maximize tax-free allowances. For example, basic-rate taxpayers can earn up to £1,000 of interest from cash outside an ISA tax-free, while higher rate taxpayers have a £500 allowance, and top-rate taxpayers have none. Additionally, individuals can earn up to £500 annually from dividends without incurring taxes.

For parents of young children, it may be beneficial to lower your earnings to avoid exceeding the £100,000 threshold. Robert Salter from Blick Rothenberg pointed out, “Some individuals have opted to increase their holiday time or reduce their hours to decrease their salary and thereby maintain access to free childcare.”

The Treasury was approached for comment.