‘Beware!’ Britons warned of ‘60% tax trap’ that could leave you paying more – how to avoid

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As bills continue to rise, many people will be wondering how they can cut costs this year to survive the financial squeeze. Mike Barrow, financial coach at Claro Money has explained exclusively to Express.co.uk what the tax trap entails and how someone can avoid it and save money.

He reminded Britons that pension contributions attract tax relief.

He explained that through the typical ‘relief at source’ method whereby pension contributions are made or collected after tax, basic rate tax relief is given automatically in the form of additional contributions into your pension.

Higher rate taxpayers can claim additional tax relief but this is not done automatically and must be claimed via self-assessment.

Tax relief can usually be claimed and backdated up to the previous four tax years.

He said: “Beware of the 60 percent tax trap. People earning an adjusted net income of over £100,000 per tax year will start to lose £1 of their personal allowance for every £2 that they earn over the £100,000 threshold.

“This means that those earning £125,000 or more will have zero personal allowance and will begin paying tax from the very first pound they earn.”

Mr Barrow explained that the term adjusted net income is “key” here.

Adjusted net income is someone’s total taxable income minus certain tax reliefs.

This is often referred to as the “60 percent tax trap” as any income between £100,000 to £125,000 is in essence taxed at an effective rate of 60 percent (higher rate tax plus loss of allowance at 20 percent).

In order for people to reclaim their personal allowance, Mr Barrow suggested pension contributions.

He said: “One of the more popular tax reliefs to use are pension contributions.

“Generally any pension contributions made will reduce your adjusted net income (in line with the amount you contribute) which in turn can reclaim your personal allowance either partly or fully depending on the amount you contribute.

“Be aware that you can usually contribute a maximum of £40,000 to a pension per tax year while still receiving tax relief.

“However you can often ‘carry forward’ any unused allowance from the previous three years if you wanted to contribute more than this.”

Mr Barrow went on to discuss how this applies for those people who are self-employed.

He continued: “For those that are self-employed under the typical sole trader status, it may (certainly not always) be worth considering setting up and registering your business as a limited company.

“The tax reporting is often more complicated however, for those that draw an income from a limited company (depending on the amount) the tax burden is often reduced.

“This is largely due to the option of drawing dividends from company profit.

“Using this method, company directors can utilise the dividend allowance (currently £2,000) while also benefiting from lower tax rates on dividends in comparison to salary.

“This is 8.75 percent for basic rate (rather than 20 percent for salary) 33.75 percent for higher rate (rather than 40 percent) and 39.35 percent for additional rate taxpayers (rather than 45 percent).”

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