A significant number of British state pensioners are facing a punishing effective tax rate of 60%, a direct result of a specific and often misunderstood rule within the UK's earnings system.
The £100,000 Earnings Quirk Explained
According to new data, 77,000 individuals at or above the state pension age of 66 were caught in this high-tax net during the 2024/25 tax year. This so-called '60% tax trap' specifically targets those with incomes falling between £100,000 and £125,140.
The mechanism behind this steep effective rate is the gradual withdrawal of the personal tax-free allowance. For every £2 earned over the £100,000 threshold, an individual loses £1 of their tax-free allowance. This loss, combined with the standard 40% higher-rate income tax, creates a marginal tax rate of 60% on that portion of their income.
Frozen Thresholds Pull In More Pensioners
Craig Rickman, a pensions expert at Interactive Investor, highlighted the growing impact of this issue. He noted that with more people choosing to work into their late 60s, including high earners, this tax rule is affecting a larger group.
"This data reveals the punishing impact of the 60% tax trap on older workers, as frozen tax thresholds pull more pensioners’ incomes into six-figure territory," Rickman stated. He provided a stark comparison, explaining that if the tax-trap threshold had risen with inflation, it would now stand at approximately £155,000, shielding many from this burden.
With the current deep freeze on income tax bands scheduled to last until at least 2028/29, there are concerns that thousands more pensioners will be subjected to this punitive tax rate on parts of their income in the coming years.
Potential Solutions and Impact on Workforce
This situation raises economic concerns, as Rickman warned that such high effective tax rates could disincentivise work. "As taxes take an even bigger bite from the cherry, many older high earners will weigh up whether they’re better off stepping back and earning less, rather than risk facing such a heavy tax burden," he said. This could potentially lead to a loss of valuable older talent in the workforce.
For those affected, there is a potential strategy to mitigate the impact. Rickman advised that paying into a pension to bring taxable income below £100,000 can be effective. This move not only reduces your income for the threshold calculation but also attracts 40% income tax relief and helps retain your full personal tax-free allowance.
He added an important note for those with private pensions, such as a Self-Invested Personal Pension (SIPP): "Just don’t forget to include the pension contribution on your tax return... as you only receive the 20% basic-rate relief upfront."
