How rising income can cost you valuable tax allowances and benefits
Higher earnings should mean more disposable income, but the UK tax system has thresholds where allowances are withdrawn.
For many taxpayers, an increase in income feels like a straightforward positive. Higher earnings should mean more disposable income, even after paying a bit more tax. In practice, the UK tax and benefits system does not always work that way.
There are a number of income thresholds built into the system where allowances and state benefits are reduced or withdrawn altogether once income exceeds a certain level, creating punitive marginal tax rates.
Personal allowance withdrawal above £100,000
One of the most significant thresholds in the UK tax system applies once income exceeds £100,000. For every £2 of income above this level, £1 of the personal allowance is withdrawn. This creates an effective marginal income tax rate of 60% on earnings between £100,000 and £125,140. Once income reaches £125,140, the personal allowance is completely lost. For individuals in this bracket, a pay rise or a bonus can result in remarkably little extra take-home pay.
The High Income Child Benefit Charge
Child Benefit is another area where rising income can trigger complex tax charges. Following recent reforms, the High Income Child Benefit Charge (HICBC) now applies when the highest earner in a household has an adjusted net income above £60,000. The benefit is gradually withdrawn at a rate of 1% for every £200 earned above this threshold, and is completely cancelled out once income reaches £80,000. This requires the higher earner to complete a Self Assessment tax return to pay back the benefit via the tax charge.
Loss of tax-free childcare and free hours
The childcare support system contains a particularly harsh 'cliff edge'. Working parents can claim up to £2,000 per year per child in Tax-Free Childcare, and access 30 hours of free childcare for 3 and 4-year-olds. However, if either parent's adjusted net income exceeds £100,000 by even a single pound, all entitlement to these schemes is lost instantly. For a family with two young children, earning £100,001 instead of £99,999 could leave them thousands of pounds worse off overall.
Mitigating the impact
If your income is approaching any of these thresholds, proactive tax planning is essential. Making additional pension contributions or charitable donations under Gift Aid can reduce your 'adjusted net income', potentially preserving your allowances and benefits while boosting your retirement savings or supporting a good cause.
Disclaimer
The information contained in this article is for general guidance on matters of interest only. It should not be used as a substitute for consultation with professional accounting, tax, legal, or other competent advisers. Before making any decision or taking any action, you should consult a Kingscott Dix professional.