The UK income tax system can seem daunting, but understanding its intricacies can save you both money and stress. As an employee, knowing how your income is taxed, particularly if you are a high earner, is crucial. This blog will provide an overview of the UK income tax system for 2024/25, with a particular focus on the implications of losing your personal allowance if your income exceeds £100,000.
Have you ever wondered how much of your hard-earned salary goes to taxes? For many employees in the UK, understanding the tax system is essential, especially as income increases. For those earning over £100,000, the rules change significantly, often leading to unexpectedly high tax rates. This blog will break down the key aspects of the UK income tax system for 2024/25 and explain how losing your personal allowance over £100,000 works, including the hidden rates of tax involved.
Overview of the UK Income Tax System
The UK income tax system is progressive, meaning that higher earners pay a higher percentage of their income in tax. For the 2024/25 tax year, the key income tax bands are as follows:
- Personal Allowance: Up to £12,570 (0% tax)
- Basic Rate: £12,571 to £50,270 (20% tax)
- Higher Rate: £50,271 to £125,140 (40% tax)
- Additional Rate: Above £125,140 (45% tax)
Losing Your Personal Allowance Over £100,000
One of the most significant features of the UK tax system for high earners is the reduction of the personal allowance. When your income exceeds £100,000, your personal allowance (£12,570 for 2024/25) reduces by £1 for every £2 earned over £100,000. This effectively introduces a hidden tax rate as you lose the benefit of your personal allowance.
How It Works
- If you earn £100,000, you retain your full personal allowance of £12,570.
- For every £2 you earn over £100,000, your personal allowance reduces by £1.
- This means that by the time your income reaches £125,140, your personal allowance is completely eroded.
Hidden Rates of Tax
This reduction in personal allowance creates an effective marginal tax rate of 60% for incomes between £100,000 and £125,140. Here’s a closer look:
- Income from £100,000 to £125,140: For each £2 earned, £1 of personal allowance is lost, which is effectively taxed at 40% (higher rate). The loss of the £1 allowance means you pay an extra 40p per £1, which is the equivalent of 20% for every £2 over the £100,000 threshold. Added to your 40% tax band, this gives the hidden 60% tax band.
For example, if you earn £120,000:
- Your personal allowance reduces by £10,000 (£120,000 - £100,000 = £20,000 / 2).
- The taxable income increases by £10,000 due to the lost allowance, resulting in a higher effective tax rate.
Practical Tips to Manage Your Tax Liability
Navigating the UK tax system, especially as a high earner, requires careful planning. Here are some practical tips:
- Pension Contributions: Contributing to a pension can reduce your taxable income, potentially retaining more of your personal allowance.
- Charitable Donations: Gifts to charity can also reduce your taxable income.
- Salary Sacrifice Schemes: Consider salary sacrifice arrangements for benefits such as company car schemes or additional pension contributions.
- Professional Advice: Consult with a tax advisor to explore all available options for tax efficiency.
Understanding the UK income tax system and the implications of losing your personal allowance when earning over £100,000 is crucial for effective financial planning. By recognising the hidden rates of tax and implementing strategies to manage your tax liability, you can make informed decisions about your finances.
In summary, the UK income tax system is designed to be progressive, but it also includes complexities that high earners need to navigate. The loss of personal allowance over £100,000 introduces an effective 60% tax rate, making it essential to seek professional advice and utilise available tax reliefs to minimise your tax burden.
Have any questions or need further advice on managing your tax liability? Reach out to Donaldson Ross & Co today. Don't forget to share this blog with your colleagues to help them understand the nuances of the UK income tax system too!