Once you start earning over £100,000, this should feel like a milestone. However, it often triggers one of the UK’s most punishing tax outcomes – the so-called £100K tax trap. Without careful planning, this can push your marginal tax rate to an eye-watering 60%. In this post, we explore ways to beat the £100K tax trap, so you can keep more of what you earn.
Why income above £100,000 attracts extra tax
The issue centres around the Personal Allowance. Most taxpayers receive a tax-free allowance each year. However, HMRC withdraws this once your adjusted net income exceeds £100,000.
Consequently, for every £2 you earn over £100,000, you'll lose £1 of your allowance. As a result, by the time you’re earn £125,140, there’s no personal allowance left. The term £100K tax trap refers to the fact that any income between £100,000 and £125,140 is effectively taxed twice:
With a salary of £102,000, you lose £1,000 of your personal allowance. That means £1,000 of income that was previously tax-free is now taxed at 40%, As a result, this costs you an extra £400.
Additionally, you’ll also pay 40% tax on the £2,000 of income above the threshold, which is £800. This all adds up to an effective tax rate of 60% on that portion of income.
In total, that’s £1,200 of tax on £2,000 of income – an effective tax rate of 60%.
What Is Adjusted Net Income?
Adjusted Net Income (ANI) is essentially your total taxable income minus certain deductions. It includes:
To arrive at your adjusted net Income you deduct the following:
Crucially these deductions can create tax planning opportunities.
Using Pension Contributions to Reduce Your Adjusted Net Income
Pension contributions are the most powerful tool for reducing your Adjusted Net Income.
Using salary sacrifice can strengthens this strategy further. So instead of paying salary, your employer funds your pension directly, reducing your taxable income and both employee and employer National Insurance contributions.
Example - Company Pension Contribution
John earns a salary and dividends totaling £120,000 from Finch Enterprises Ltd
This exceeds the £100,000 threshold by £20,000. As a result, £7,500 of his Personal Allowance disappears creating an additional tax liability of up to £6,000.
However, John reduces his salary to £80,000 in exchange for a £20,000 employer pension contribution. This restores his full Personal Allowance and saves both income tax and NIC. His company also benefits from corporation tax relief on the contribution.
Don't Forget the Pension Carry Forward Rules
Many high earners overlook pension carry forward. You can use unused annual pension allowances from the previous three tax years, allowing large one-off contributions in years of high income. However, advance planning is essential to avoid exceeding the annual allowance.
Example 2 - Using pension carry-forward
Jackson is a partner in Slow Horses LLP his projected profit share after a strong year is £175,000.
However, he has £15,000 of unused pension allowances from previous years. He decides to make a gross pension contribution of £75,000 using the current and previous years’ allowances.
As a result, his Adjusted Net Income drops to £100,000, restoring his full Personal Allowance and significantly boosting his pension.
Using Gift Aid donations as an alternative strategy
Gift Aid donations can also reduce your Adjusted Net Income. HMRC grosses up donations (e.g. a £12,000 donation becomes £15,000 for tax purposes), which also extends your basic rate band. This can help recover part or all of your Personal Allowance, especially when used alongside pension planning.
Example 3 - Using Gift Aid Donations
James is a director of Enterprise Ltd and receives salary and dividends totaling £115,000.
He makes a Gift Aid donation of £12,000 (grossed to £15,000). Consequently, his Adjusted Net Income falls to £100,000, fully restoring his Personal Allowance.
Common mistakes high earners make
Many individuals make the following mistakes:
How to beat the £100K tax trap in practice
Adopting the following approach can be highly effective:
This structured approach is one of the most effective ways to beat the £100K tax trap.
Summary
The £100K tax trap can penalise unexpected increases in income – such as from a bonus or dividend. But it's entirely manageable if you understand how Adjusted Net Income works.
Pension contributions remain the most powerful tool for restoring lost allowances and reducing tax. With forward planning, you can protect your income, make efficient use of tax reliefs, and beat the £100K trap.
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