Understanding how much income you can earn before hitting the 40% tax bracket is essential for effective financial planning. Whether you’re an employee, self-employed, or earning income from other sources, knowing your tax obligations helps you manage your money more efficiently and avoid surprises when it comes to paying HMRC.
This guide will walk you through how the UK tax system works, what the 40% tax bracket means, and how much you can earn before crossing into higher-rate tax territory. We’ll also touch on strategies you can use to minimize your tax liability legally.
The UK Tax System Explained
The UK operates a progressive tax system, meaning the more you earn, the higher the percentage of your income you pay in taxes. In the 2024/25 tax year, the personal allowance – the amount you can earn before paying any tax – is £12,570. After this threshold, income is taxed in brackets:
- Basic rate (20%): For income between £12,570 and £50,270.
- Higher rate (40%): For income between £50,271 and £125,140.
- Additional rate (45%): For income over £125,141.
It’s important to note that the personal allowance decreases for high earners. For every £2 earned above £100,000, the personal allowance is reduced by £1, until it is eliminated at £125,140.
How Much Can You Earn Before Paying 40% Tax?
In the 2024/25 tax year, the threshold for paying 40% tax begins at £50,271. This means that any income above this level will be taxed at a higher rate. However, the first £50,270 of your income will still be taxed at 20%.
Example:
If your total income for the year is £60,000, the breakdown would look like this:
- £12,570 (personal allowance): 0% tax
- £37,700 (taxable at the basic rate): 20%
- £9,730 (taxable at the higher rate): 40%
While only the portion above £50,270 is taxed at 40%, it’s crucial to understand that other forms of income – such as interest from savings, rental income, or dividends – can also push you into the higher tax bracket.
What Happens if You Earn Over £100,000?
Once your income exceeds £100,000, your allowance starts to taper. This has a significant impact because you effectively pay a 60% marginal tax rate on income between £100,000 and £125,140. Why? As your allowance decreases, more of your income becomes subject to tax, creating a higher effective rate.
Example:
If you earn £120,000:
- You lose £10,000 of your allowance (£20,000 over £100,000, divided by 2).
- This leaves you with a personal allowance of £2,570.
- The remaining £97,430 is taxed at a combination of basic (20%) and higher (40%) rates.
At this point, financial planning becomes even more essential. If you’re close to the £100,000 threshold, contributing to a pension or making charitable donations can reduce your taxable income and preserve your allowance.
National Insurance Contributions
In addition to income tax, National Insurance Contributions (NICs) also impact how much you take home. For employees, NICs are payable at:
- 12% on earnings between £12,570 and £50,270.
- 2% on earnings over £50,270.
Self-employed individuals have slightly different NIC rates, including Class 2 and Class 4 contributions. These also affect how much of your earnings remain after taxes.
Reducing Your Tax Bill
Although you can’t avoid taxes entirely, several strategies can help you reduce your taxable income and stay below the 40% threshold for longer. Here are some of the most common:
1. Maximize Pension Contributions
Contributing to a pension is one of the most effective ways to reduce your taxable income. Payments into a pension are made before tax is deducted, reducing the amount of income subject to the 40% rate.
2. Utilize Gift Aid
If you regularly donate to charity, ensure you’re claiming Gift Aid. Charitable donations through Gift Aid extend your basic rate band, meaning you can earn slightly more before paying a 40% tax.
3. Take Advantage of ISAs
Income earned from an Individual Savings Account (ISA) is tax-free. By investing in ISAs, you can grow your savings and investments without pushing yourself into a higher tax bracket.
4. Claim Work-Related Expenses
If you’re self-employed, don’t forget to claim legitimate business expenses. Doing so reduces your taxable income, meaning less of your earnings are subject to the 40% tax rate.
Tax-Free Allowances You Should Know About
Besides the personal allowance, several other tax-free allowances can help reduce your tax liability:
- Savings allowance: Basic-rate taxpayers can earn up to £1,000 in savings interest without paying tax, while higher-rate taxpayers can earn up to £500.
- Dividend allowance: All taxpayers can earn up to £1,000 in dividend income before paying tax on it.
- Marriage allowance: If you’re married and one partner earns less than the personal allowance, you may be eligible to transfer up to 10% of the personal allowance to the higher-earning partner, reducing their tax liability.
Planning for Future Tax Changes
The government occasionally adjusts tax thresholds and allowances, affecting your tax planning strategy. Keeping abreast of these changes and adjusting your finances accordingly is vital.
For instance, the current higher-rate threshold of £50,271 is frozen until 2026. As wages rise over time, more people may find themselves in the 40% tax bracket, which is known as “fiscal drag.” Planning by maximizing tax-efficient savings and investments can mitigate this impact.
Get more help from Stones Accountancy
Understanding how much you can earn before paying 40% tax in the UK is crucial for financial planning. By maximizing available allowances, utilizing tax-efficient savings methods, and staying informed about upcoming changes, you can ensure that more of your hard-earned money stays in your pocket.
If you’re unsure how the 40% tax bracket affects you, or if you’re looking for ways to optimize your finances, Stones Accountancy is here to help. We offer tailored tax advice and financial planning services to ensure you make the most of your income and minimise unnecessary tax liabilities. Contact us today to discuss your options and plan for a tax-efficient future.