How a 1p pay rise can now price you £38,000… simply one of many tax cliff edges the Budget’s made even worse

Half a million people will be stung for the first time by outrageous traps in the tax system that punish workers for getting a pay rise.

Chancellor Rachel Reeves’ extended freeze on income tax thresholds will slap hundreds of thousands of workers with tax rates far exceeding the advertised top rate of 45 per cent.

There have long been vicious cliff edges in the tax system that punish hard workers but a record number will be caught out by them as a result of this stealth tax.

One such quirk is so absurd, it scarcely seems possible. Parents earning £99,999.99 could miss out on £38,000 worth of tax breaks and free childcare if their salary grows by as little as 1p.

The tax system is littered with these chokeholds and you don’t need to earn six figures to be hit with a 71 per cent marginal tax rate. Here, we look at the worst traps and what you can do to duck below the all-important thresholds.

All these rates apply in England. In Scotland, thresholds and rules differ.

Anyone earning £100,000-£125,140 a year

Marginal tax rate: 60 per cent

Higher earners taking home between £100,000 and £125,140 face one of the worst tax cliff edges if they receive any pay rises. Their extra earnings are snatched away by a punishing mix of tax tapers and retracted allowances.

Workers do not pay tax on the first £12,570 of their earnings, the ‘personal allowance’. But from £100,000 this allowance is tapered away at a rate of £1 for every extra £2 of income they make, until they reach £125,140 – when they no longer have any tax-free allowance. This works out at an effective tax rate of 60 per cent.

An extra 493,000 people will be stung by this rate in the next four years, according to estimates from the Government obtained by wealth manager Rathbones. The number of taxpayers earning above the £100,000 threshold is expected to increase from 1.8million last tax year to 2.3million by 2029/30.

Stephanie Ebner, a financial planner at Rathbones, said: ‘The £100,000 tax trap is one of the most baffling quirks in our tax system. Originally designed to target the very highest earners, it now ensnares thousands who were never meant to be caught.’

£100,000-£125,140 a year (and if you have young children)

Marginal tax rate: up to 380,000,000 per cent

The most extreme cliff edge kicks in at the £100,000 a year mark for families with young children. Since September, parents with children between nine months and three years are entitled to 30 hours a week of free childcare.

However, if just one parent has a taxable income of £100,000 a year or more, they will not qualify for any help. This is separate to the 15 hours of free childcare parents of three and four-year-olds receive regardless of income.

Parents earning above this threshold also lose a government top-up worth up to £2,000 a year towards the cost of childcare.

This means a family with two children at nursery would miss out on £33,328 worth of government tax breaks and funding if one parent’s income rises by as little as 1p above £100,000, says wealth manager Quilter.

Parents whose earnings tip over £100,000 a year also face that tapering of their personal savings allowance in a further hit.

Had income tax thresholds risen with inflation, earners today would only start to lose their personal allowance at £154,000 and their childcare perks at £133,000, according to Quilter. Its calculations found that families with two young children earning between £125,140 and £132,999 are £38,356 worse off compared to if the thresholds had risen.

This loss of £38,000 for a 1p salary increase translates to a marginal rate of 380,000,000 per cent. It is the only tax cliff edge at which workers are actually worse off if they get a raise.

Shaun Moore, financial planning expert at Quilter, said: ‘The £100,000 cliff edge has become one of the most damaging distortions in the tax system.’

£60,000 a year

Marginal tax rate: 98.2 per cent

Parents are stung with another dramatic spike in their tax rate at the £60,000 salary mark. Middle-class families are being taxed as much as 98.2 per cent on every £1 they earn above £60,000 if they have three children, according to Tax Policy Associates. This means that for every £100 they earn, they take home only £1.80.

This is because of a combination of tax thresholds and benefits cut-off points that whittle away their additional earnings. Child benefit starts to decrease when one parent earns £60,000 and is entirely withdrawn from £80,000 a year. For those who earn £60,000 or more, the benefit is gradually withdrawn. The ‘high income child benefit charge’ is levied at

1 per cent of the total benefit for every £200 of income over £60,000.

Anyone who started university from 2012 onwards and earning more than £28,470 a year will pay an effective tax rate of 9 per cent on top of other tax obligations through student loan repayments. This takes them to an overall marginal rate of 98 per cent.

This is one of the highest marginal deduction rates in the UK, according to Tax Policy Associates, at 71.3 per cent for families with one child, 84.8 per cent for those with two children and 98.2 per cent for those with three children. Child benefit typically pays £26.05 a week for your first child and £17.25 a week for any children after that.

What you can do

The good news is there are ways to reduce the income that the Treasury will tax you on without having to turn down a pay rise.

Charlotte Kennedy, a financial planner at Rathbones, says workers can duck back under the thresholds by lowering their taxable income. You can do this by making extra contributions to your pension or by opting for a salary sacrifice scheme at work.

Making charity donations is another way to avoid losing the free hours of childcare. Your basic rate tax band increases by the value of the charitable gift.

Salary sacrifice is a scheme that companies can use to provide workplace benefits to their staff such as pension contributions, a company car or a bicycle for cycle-to-work schemes.

It is a tax-efficient way for employers and employees to make pension contributions because it reduces the amount of National Insurance both pay.

But beware – the Chancellor announced a £2,000 cap on the pension contributions you can make via salary sacrifice without paying National Insurance.