How pay raises can actually erode wealth

A salary increase should be cause for celebration, especially with the current cost of living stretching even the largest paycheques.

However, in reality, for a growing number of UK earners, hitting certain income thresholds can mean keeping less of every additional pound than they expected.

Frozen tax bands, the tapering of the Personal Allowance and the High Income Child Benefit Charge all combine to create some genuinely punishing effective tax rates.

If you have just had a pay rise or are hoping for one soon, it is worth understanding exactly where the tax traps are easily sprung.

The £100,000 cliff edge

The most punishing of all is the loss of the Personal Allowance for earnings between £100,000 and £125,140.

The Personal Allowance is the £12,570 of income you can earn tax-free. Once your adjusted net income passes £100,000, that allowance is reduced by £1 for every £2 of income above the threshold, which means by £125,140 it has gone entirely.

On every pound earned between £100,000 and £125,140, you lose 40 per cent in higher-rate Income Tax plus a further 20 per cent through the lost allowance, giving an effective marginal rate of 60 per cent. Throw in National Insurance and your rate of take home pay shrinks even faster.

The High Income Child Benefit Charge

If you or your partner claim Child Benefit, another trap kicks in once either of your individual incomes passes £60,000.

Between £60,000 and £80,000, Child Benefit is gradually clawed back through the High Income Child Benefit Charge. Above £80,000, it has been wiped out entirely.

For a family with two children, this can add the equivalent of an extra eight to 10 per cent of marginal tax to that income band.

Combined with higher-rate Income Tax and National Insurance, some parents face effective marginal rates of around 60 per cent on income they had assumed would simply boost the household.

Frozen thresholds are quietly making it worse

Most Income Tax thresholds have been frozen since 2021/22 and are due to stay frozen until at least 2031, but wages continue to grow as employers battle with inflation to retain the best talent.

That mismatch is what the Office for Budget Responsibility calls “fiscal drag”. Every year, more people are dragged into higher-rate tax, the Personal Allowance taper or the Child Benefit charge simply because their pay has gone up with inflation, while the thresholds have not.

If you were a basic-rate taxpayer a few years ago, a couple of routine pay rises may have quietly pushed you into a much higher effective rate. Whilst you may still take home more cash than before after tax, a larger proportion of your salary is being taxed.

What you can do

There are several ways to reduce your adjusted net income so that you can continue to benefit from each new pay rise:

• Pension contributions – Increasing personal or salary sacrifice contributions reduces taxable income.
• Gift Aid donations – Allows you to extend your basic rate band and reduce adjusted net income for the £100,000 threshold.
• Salary sacrifice for other benefits – Cycle to work schemes, electric vehicles and additional holiday are all forms of tax efficient benefit in kind to consider.
• Timing of bonuses – Where flexibility exists, deferring income across tax years can help, so where possible ask if you can delay bonuses or other performance related pay.

If you have had a pay rise or expect to cross one of these thresholds in the current tax year, get in touch. We can model your position and help you take home more of what you earn.