Financial experts at AJ Bell have urged the new Prime Minister Andy Burnham and Chancellor John Healey to reassure high earners in the upcoming Budget, due to a 60% tax trap and concerns about pension tax relief often used to avoid it.
60% Tax Trap Explained
AJ Bell points out that an effective 60% tax rate currently exists in the Income Tax system due to a Personal Allowance rule. High earners losing the tax-free Personal Allowance at £100,000 income face this trap. Sarah Coles, Head of Personal Finance at AJ Bell, said: “Each pay rise will push many higher earners closer to the £100,000 point, and creeping over this can be incredibly costly. Anyone with earnings between £100,000 and £125,140 faces an effective tax rate of 60%, because for every £2 you earn over £100,000, you lose £1 of your personal allowance. Once you earn £125,140, you will have lost the allowance entirely, and you move into the 45% tax bracket.”
There is also a separate allowance for pensions for high earners. Coles added: “Likewise, crossing the threshold into the tapered annual allowance for pensions can throw a spanner in the works. Very broadly this kicks in when you earn more than £200,000 and your ‘adjusted income’ is above £260,000. This includes a number of things on top of your net income, but most significantly it includes pension contributions.”
Call for a Pensions Tax Lock
Currently, those affected can use pension contributions to avoid the 60% tax trap, but AJ Bell is worried that speculation around tax relief rule changes could lead to poor decisions before the Budget in October. Coles said: “One question that always comes up before a Budget is whether the tax relief on pensions is safe – something that would particularly affect higher earners.”
“The consistent re-emergence of the topic ahead of each Budget is why AJ Bell has urged Healey to commit to a Pensions Tax Lock well in advance of 28th October by pledging not to alter tax relief or tax-free cash and prevent damaging speculation pushing people into making knee-jerk decisions about their long-term finances.”
Healey’s Response
Healey has denied he will raise taxes to pay for pledges made by Burnham when he became Prime Minister, which include a temporary cut on VAT on electricity and relief for pubs and bars. He said he would set out his “plans for taxation” at the Budget, to be unveiled on October 28, and vowed to “live with the fiscal discipline, within the fiscal rules”.
Asked whether taxpayers should expect to pay more for Burnham’s first policy announcements, Healey told ITV News: “No. The announcements we made as a new Government in the last few weeks, we know how we’re going to pay for them. In the budget, I’ll set out whole plans for the economy, plans for taxation, plans for the future. And that will be how we’d get activity, we get hope, we get growth back in every postcode.”
