The £100,000 tax trap

Between £100,000 and £125,140 the UK income tax system charges an effective 60% — higher than the 45% additional rate that applies above it. Here is why, and what to do about it.

The mechanism

Everyone starts with a personal allowance of £12,570 — income you pay no tax on. Above £100,000 of adjusted net income, that allowance is withdrawn at £1 for every £2 you earn.

So earning an extra £100 in this range does two things at once:

• The £100 itself is taxed at the higher rate of 40% — that is £40.
• You lose £50 of personal allowance. That £50, previously untaxed, is now taxed at 40% — a further £20.

£60 of tax on £100 of extra earnings. An effective marginal rate of 60%, sustained across the whole £25,140 band until the allowance reaches zero at £125,140.

It is worse in Scotland

Scottish taxpayers in this range pay the 45% advanced rate rather than 40%, so the same mechanism produces an effective marginal rate of 68.0% — the highest rate anywhere in the UK tax system.

The absurd bit

Above £125,140 the allowance is gone, so the trap ends and the marginal rate falls to the 45% additional rate. Someone on £130,000 faces a lower marginal rate than someone on £110,000. A pay rise from £99,000 to £105,000 is worth considerably less after tax than the same rise from £130,000 to £136,000.

What actually helps

Pension contributions

The trap runs in reverse. A pension contribution reduces your adjusted net income, restoring allowance as it goes — so relief comes at the same 60%.

On a £110,000 salary, a £10,000 contribution takes adjusted net income to exactly £100,000. Your personal allowance goes from £7,570 back to the full £12,570, and your income tax bill falls by £6,000. That is 60% relief on money you keep — it has gone into your pension, not to HMRC.

All three pension arrangements achieve this, because all three reduce adjusted net income. Under relief at source you must claim the extra through Self Assessment; it does not happen automatically.

Salary sacrifice on a bonus

If a bonus is what pushes you over £100,000, sacrificing it into your pension before it is paid avoids the trap entirely, and saves National Insurance as well — the only pension arrangement that does.

Gift Aid donations

Charitable donations under Gift Aid also reduce adjusted net income, extending your basic rate band by the grossed-up amount. The mechanism is the same as relief at source.

The childcare cliff

If you have young children the trap is sharper still. Tax-Free Childcare and the 30 free hours are both lost outright once either parent's adjusted net income exceeds £100,000. There is no taper — it is a cliff. For a family with two children in nursery this can be worth several thousand pounds a year, which means the true effective rate just over £100,000 can exceed 100%. Earning more genuinely leaves some families worse off.

A pension contribution that brings adjusted net income back below £100,000 restores both. It is one of the few places in the tax system where the arithmetic is this stark.

What counts as adjusted net income

Not just salary. It includes bonuses, taxable benefits in kind such as a company car, rental profit, dividends and savings interest — then subtracts gross pension contributions and Gift Aid donations. It is the pension and Gift Aid deductions that give you a lever.