Avoiding higher rate tax traps

When your income goes up, you need to step up your planning too. With tax thresholds having been frozen in the UK since 2021/22, the number of people paying the higher rate of tax has risen by 2.65m since that time.

We talk about some of the taxation pitfalls, and ways that you can maximise your pensions and ISA allowances to make the most of your earnings.

Use the player icons above to listen on your favourite podcast app, or read the full transcript below.

This podcast isn’t personal advice. If you’re unsure what’s right for you, seek financial advice. Pension and tax rules can change, and benefits depend on personal circumstances. Investments can fall as well as rise in value, so you could get back less than you invest.

Full podcast episode transcript

[0:05] Helen Morrissey: Hello and welcome to the Switch Your Money On podcast from Hargreaves Lansdown. I’m Helen Morrissey, and I’m Head of Retirement Analysis.

[0:13] Clare Stinton: And I’m Clare Stinton – Financial Wellbeing Lead.

The topic we’re going to be unpacking is Tax – specifically, tax traps. I can’t tell you how many times I’ve heard the saying, ‘Only two things are certain in this life – death and taxes.’

Helen – any idea who said that?

[0:30] Helen Morrissey: It sounds like something that my mum would say, Clare.

[0:32] Clare Stinton: [Laughs] I’ve definitely had my mum say it, and my dad. I’ll give you a clue – it’s the same person behind the phrase, ‘Time is money.’

[0:40] Helen Morrissey: Right – well, I do know that phrase too, but I must admit, I’m a little bit stumped as to who it is, so you’re gonna have to tell me.

[0:46] Clare Stinton: Benjamin Franklin – ...

[0:47] Helen Morrissey: Okay!

[0:48] Clare Stinton: ...but what he didn’t mention is that, while taxes are part of life, they don’t have to be just something that happens to you.

With smart planning, you can avoid some costly traps. So, today, we’re digging into higher-rate tax traps – what they are, and how you can avoid falling into them.

[Pause]

[1:05] Clare Stinton: Helen, we all look forward to a pay rise – some of us might even be working towards promotion and that bigger salary. But, when your income goes up, does that mean you need to step up your planning game too?

[1:16] Helen Morrissey: Well, it can do, Clare, yes.

So, the prospect of a pay rise is always appealing – but, for some people, it does bring some hidden challenges with it. So, for a start, tax thresholds have been frozen since 2021-2022. This means that people are slowly being drawn into paying more tax over the years, and we have seen more people then passing the threshold into paying higher and additional rates of tax.

So, the latest data shows that there’s more than 7 million higher rate income taxpayers in the current tax year. This is up 2.65 million since this threshold was frozen. Numbers of additional rate taxpayers have also risen – they’ve more than doubled over this period.

[1:59] Clare Stinton: Those are some big increases – so let’s just remind everyone what those thresholds are.

So, higher rate income tax at 40% begins from £50,271 – but, had that moved with inflation, today, it would be nearly £63,000 – that’s a 25% increase. The additional rate threshold is now at £125,140 – it was higher at £150,000, but this was lowered in April 2023. So, for anyone earning above £125,140, income tax is 45%.

Some of our listeners might be surprised to hear that 45% isn’t the most punitive rate in the system – is it, Helen?

[2:42] Helen Morrissey: No, it’s not, unfortunately.

So, once you earn £100,000, your personal allowance is cut by £1 for every £2 that your adjusted net income is above that level. This means that your allowance becomes zero once you earn that £125,140, and it gives you an effective tax rate of 60% – so that’s eye-watering. And this threshold hasn’t moved since it was introduced back in April 2010.

[3:16] Clare Stinton: That is the tax trap that really flies under the radar.

Frozen at £100,000 since 2010 – so, again, if it had moved with inflation, the threshold at which you’d now lose your personal allowance would be around £156,000. So, it’s no wonder we’re seeing millions more people scooped into the higher rate taxpayers’ net.

But income tax isn’t the only thing that can increase when you step up a tax band – is it, Helen?

[3:39] Helen Morrissey: No, you’re right – and, as I say, there’s some absolute eye-popping figures that you’ve just mentioned there. But, while paying more tax on a chunk of your salary is bad enough, there’s also several other sneaky traps lying in wait for higher earners when they cross the threshold.

So, when you first start paying 40% income tax, it automatically bumps up the rate that you pay in some other taxes as well – from savings to dividend tax, for instance.

So, dividend tax for basic rate taxpayers is set at 8.75% – and, for higher rate taxpayers, it’s 33.75%. Now, this increased in April 2022, but it is set to rise again this April to 10.75% for that basic rate taxpayer, and 35.75% for higher rate. The tax-free allowance has also fallen from £5,000, back in 2017-2018, to just £500 in the current tax year – so this is pushing more people into paying this tax.

So, if I go onto thinking about another tax that you need to think about – and we’ve got Capital Gains Tax. So, you will pay a higher rate of CGT after crossing the thresholds – and, since October 2024, the rate for gains on stocks and shares has risen to 18% for basic rate taxpayers, and 24% for higher rate taxpayers.

So, in the current tax year, you can make gains of £3,000 before you have to pay this tax – however, this is down from £12,300 as recently as 2022-2023.

[5:17] Clare Stinton: So, we’ve seen both shrinking allowances and rising tax rates. But both of those taxes – dividend tax and Capital Gains Tax – are avoidable if your investments are held in an ISA. So, it’s never been more important to use ISAs to shelter your investments from tax, both now and in the future.

If you’re just starting out – by putting your money into an ISA from day-one, you can protect it from those taxes and potentially pay much less over the long run.

Helen, what about tax on savings – have higher earners seen a hike here too?

[5:47] Helen Morrissey: Yes – so we have seen some things. So, savings can be subject to income tax – and, from 2027, savings will actually attract a higher rate of income tax than other forms of income. So, basic rate taxpayers will pay 22% – higher rate taxpayers, 42% – and additional rate taxpayers... it’s gonna be 47% for them.

You’ll also have a smaller personal savings allowance – so basic rate taxpayers can make £1,000-worth of interest before needing to worry about tax – but, for higher rate taxpayers, this falls to just £500. If you’re an additional rate taxpayer, you don’t get anything.

So, the Personal Savings Allowance also hasn’t risen since it was introduced back in April 2016 – so it’s another one of those frozen tax thresholds that’s causing us trouble.

[6:39] Clare Stinton: It’s the tax-rise hat trick. So, more and more people are ending up paying income tax on their savings – and, in fact, actually, it’s forecast that around 2.64 million people will pay tax on savings interest this tax year. That’s a big jump from just around 650,000 people in 2021/2022, when those income tax thresholds were frozen. And that’s, in part, due to interest rates that we’ve seen on cash over the last couple of years. Those higher interest rates have pushed savings interest up – and grown our savings – meaning more people are likely to have bigger pots and, therefore, get closer and exceed that Personal Savings Allowance. And, from April next year, the tax rates on savings will be higher than typical income tax rates – making it well worth thinking about tax-efficient options.

Using a Cash ISA can shield your savings from the taxman and keep more of the interest in your own pocket.

[7:31] Helen Morrissey: However, it is well worth saying that Cash ISA allowances are going to drop from £20,000 to just £12,000 from 2027. This is for the under-65s – so, if you’re over the age of 65, you will keep your £20,000 allowance for Cash ISAs – but it is very much a case of ‘Use it or lose it,’ this tax year and next – you’ve still got time ahead of 5^th April to make a contribution to your Cash ISA.

[7:58] Clare Stinton: That’s right. Any more tax traps to flag for higher earners, Helen?

[8:01] Helen Morrissey: Unfortunately, yes – so I’m gonna move onto the High Income Child Benefit Charge – it’s a little bit of a mouthful, isn’t it?!

[8:08] Clare Stinton: [Laughs]

[8:08] Helen Morrissey: That kicks in when one of the parents earns £60,000 or more. So, if your income – or your partner’s – has pushed over the threshold, and you are in receipt of Child Benefit, you will need to repay at least some of it through the Self-Assessment process – and, once you earn £80,000 per year, you’d need to repay it all.

Now, if you’re in a position where you’re earning, and you’re impacted by this, but you have a partner who isn’t working – you know, maybe staying at home to look after children – you need to remember that claiming Child Benefit means that you do qualify for National Insurance credits, which will count towards your State Pension. So, don’t cancel a benefit or avoid claiming it entirely – there is a way that you can claim the benefit, but waive the payment, so your partner who isn’t working will still get those National Insurance credits, but you don’t have the admin-headache of filling in Self-Assessment.

[9:03] Clare Stinton: Yeah, that’s a really important point, isn’t it? – because, in the past, some couples have chosen not to claim that Child Benefit because of the hassle of having to repay back that benefit money as tax down the line – and that actually led to lots of women not receiving their fair share of their State Pension.

[9:17] Helen Morrissey: Yeah.

[9:18] Clare Stinton: So, really important – as you say – that you claim the Child Benefit against the name of the partner who’s taking time out of work to care for the child and ensure that they get that all-important NI credit towards their State Pension.

Helen, we’ve spent a bit of time talking about possible tax pitfalls, but we haven ‘t yet mentioned the unsung hero in our financial toolkit, that doesn’t get nearly enough credit – especially when it comes to higher earners. So, drumroll for the...

[9:42] Helen Morrissey: Pension, of course – you know we’ve gotta mention the pension, haven’t we? So, we’re gonna be talking about Pension Tax Relief here. So, we know, with Pension Tax Relief, you get relief at your highest marginal rate – so, if you’re a higher rate taxpayer, for instance, you will get tax relief of 40%.

Now, you can pay up to 100% of earnings into a pension and get tax relief, or up to £60,000 per year – whichever is lower per tax year. It is also possible to carry forward unused allowances from the previous three tax years too, so it’s really handy to know. It can also help when it comes to this High Income Child Benefit Charge that we’ve just spoken about as well.

So, the benefit of paying into a pension is that it can also reduce what’s known as your ‘Adjusted net income.’

Now, if you’re a parent earning between £60,000 and £80,000 per year, cutting back towards £60,000, through your pension contribution, can mean that you reduce your High Income Child Benefit Charge, which is very useful.

[10:43] Clare Stinton: What do we mean by the ‘Adjusted net income?’

[10:46] Helen Morrissey: Yes – so I’ve mentioned this a couple of times – haven’t I? – so far.

So, the adjusted net income is your total taxable income before any personal allowances and then less certain tax reliefs – including trading losses, donations made to charity (through Gift Aid, for instance), pension contributions, pay gross before tax relief, and pension contributions where your provider has already given you tax relief at the basic rate.

Now, this can be complicated, but the key here is that you can cut your net adjustable income by making pension contributions. So, you can use pensions, then, to deal with that £100,000 tax threshold issue that we spoke about earlier as well. So, if you earn over £100,000, you will start to lose some of your Personal Allowance.

Use a pension to reduce your income, and it will cut the amount of tax that you pay at that eye-watering 60%. So, I’m gonna give you an example...

If your income was £101,000 – and you were to pay £1,000 into a pension – you’d get £400 tax relief, but you’d also take your income to that £100,000 threshold, so your Personal Allowance doesn’t taper – so you’d save even more. Plus, if a parent can bring their income back under £100,000, they may also keep their eligibility for tax-free childcare. However, it’s also worth saying that the calculation that I’ve just quoted is an example only, and all benefits quoted will depend on personal circumstances.

[12:17] Clare Stinton: As well as that £100,000 personal allowance tax trap that we’ve discussed, that £100,000 is also the threshold that you start to lose access to really valuable childcare support from the Government. So, it’s really a sweet spot for, as you say, putting money into your pension if your income does fall between that £100,000 to £125,140. Because any money that you put into your pension – so, for every £1 in that range, it effectively can cost you as little as 40p from your take-home pay – or 38p if you also save the 2% National Insurance via salary sacrifice if, you have a workplace pension. So, you are directing that money away from HMRC and into a pot for your future. And, again, you can regain access to other benefits – like that 30 hours of free childcare, which is lost if you or your partner have an adjusted net income above £100,000.

Obviously, the more you start to earn, the harder it becomes to get back close to that £100,000 threshold – for example, if you earn £150,000... to reclaim your full Personal Allowance, you’d have to make a big contribution of £50,000 to your pension. So, in the years when you can afford to take advantage of that window, it can really dramatically accelerate the growth of your pension.

The other really important thing to point out here is how Higher Tax Rate Relief works – so, if you are higher earner, and you’re contributing to a personal pension – or a workplace pension via the net method – which is also known as Relief at source... So, basically, you can check this via your payslip, and it’s whether your contribution is taken after tax – so it’s not deducted from your gross pay – then 20% basic rate tax will be automatically claimed by your pension provider – but, actually, you then need to claim the additional 20% or 25% back from HMRC – and you can either do that through your Self-Assessment, or you can do it by contacting them directly.

If your workplace scheme use a salary sacrifice, then there is nothing for you to be reclaiming – your employer deducts your contribution from your gross pay before you pay any tax or National Insurance.

So, Helen, we’ve talked about pensions – our favourite – but what about tax hacks beyond pensions?

[14:28] Helen Morrissey: Okay, yeah – so there’s a few things we can talk about here.

So, if you’ve got investments outside an ISA, it’s worth considering taking advantage of your CGT (your Capital Gains Tax Allowance) every tax year – and you can use what’s known as ‘The Bed and ISA process’ – also known as ‘Share exchange’ – to then move these assets into an ISA.

Now, don’t forget, you can offset any capital losses you make during the tax year against gains. If your total taxable gain is still over the tax-free allowance, you may be able to deduct any unused losses from previous tax years too – so it’s well worth checking. If just some of your losses reduce your gain below the tax-free allowance, you can carry forward the remaining losses to a future tax year.

So, also, if you use Bed and ISA process to shelter income-producing investments in a Stocks and Shares ISA, you won’t pay tax on dividends in the future as well. So, because the rate at which you pay dividend tax is often higher than the rate at which you will pay Capital Gains Tax, it’s often worth prioritising this when you’re making decisions about how to use your ISA allowance. Meanwhile, a Cash ISA can also protect you from tax on your savings interest.

The other thing I’d like to say is that, if you are married – or in a civil partnership – and your partner pays a lower rate of tax, you can transfer income-producing assets into their name. It means you can both take advantage of your tax allowances. You can also use all the tax-efficient vehicles at your disposal. This includes your ISAs, your pensions – as well as the Junior ISAs and Junior SIPPs of any qualifying children.

[16:06] Clare Stinton: I’d really love to know who came up with the term ‘Bed and ISA’ – ‘cause it’s absolutely, in no means, talking about tucking your ISAs and investments up into bed – it’s that classic jargon that we often encounter within the industry.

Helen, as you say, really important to flag that you can use your ISA allowance – and it is purely a Bed and ISA moving existing investments into the ISA wrapper. It’s the process by which you do that, and you don’t need spare cash to take advantage of your allowance – which is ‘Use or lose it’ by this year’s tax-year deadline, the 5^th April.

And, for those people who’ve built up assets outside of ISAs – that are liable to dividend tax and Capital Gains Tax – then a strategy to consider is repeating that Bed and ISA, or share exchange, or just refer to it as transferring your existing investments into an ISA wrapper – then you can do that each year to use your full £3,000 Capital Gains Tax Allowance, without going over it – and that can be a clever way to start to shelter assets from future tax.

[17:07] Helen Morrissey: Some great tips there, Clare.

So, now, we have come to that wonderful time of the podcast, otherwise known as ‘Stat of the week.’

There’s a little bit of a pensions theme in this – we’ve mentioned Pension Tax Relief here. So, how did Pension Tax Relief save us in 2024-2025 tax year? Gonna give you three options here...

Is it £21.5bn – £27.8bn – or £32.3bn?

What d’you think it is, Clare?

[17:40] Clare Stinton: Well, we talk, quite often, about how pensions are the unsung hero – that they are the super player within your financial toolkit, because they can save you tax on the way in – help reduce your total taxable income – and tax-efficient on exit. So, I’m gonna go for the highest figure – ‘£32.3bn.’

[17:57] Helen Morrissey: And you would be absolutely right – and, as you say, Pension Tax Relief... it is, indeed, the hidden hero, and we need to know more about it – so that’s brilliant.

So, that’s it for this week – but, before we go, we should remind you that this was recorded on March 2^nd 2026, and that all information was correct at the time of recording.

[18:15] Clare Stinton: Nothing in this podcast is personal advice. If you’re unsure about what’s right for you and your circumstances, you should seek advice.

[18:23] Helen Morrissey: Tax rules can change and benefits depend on circumstances. Pension money can’t normally be accessed until at least the age of 55 – it’s going up to 57 from 2028.

[18:34] Clare Stinton: Over five years or more, investing typically offers better returns than cash savings – but investments go up and down in value, so you could get back less than you put in.

So, all that’s left for us is to thank our Producer, Elizabeth Hotson.

[18:48] Helen Morrissey: And thank you all very much for tuning in, and we’ll be back again soon. Goodbye!

[18:52] Clare Stinton: Bye!