The £100,000 Trap: How a Pay Rise Can Leave You Worse Off
A £1 pay rise in the UK can have a significant impact on your finances, leaving you tens of thousands of pounds worse off. This may seem counterintuitive, but it’s due to a phenomenon known as the "£100,000 trap." When individuals breach this income threshold, they face a double financial whammy: losing lucrative childcare benefits and paying a higher income tax rate than the country’s top earners.
The Childcare Trap
As of this month, people earning an adjusted net income below £100,000 are entitled to 30 hours of free childcare for children aged nine months to school age. Adjusted net income refers to your salary plus interest and shares, minus pension contributions and other transactions. Those eligible are also entitled to up to £2,000 per child under 11 towards childcare costs through the Tax-Free Childcare scheme. However, once either parent breaches the £100,000 threshold, the only childcare benefits available will be 15 hours of free care for three and four-year-olds.
Real-Life Examples
Robert Murton, a 37-year-old father of two from London, earns £130,000. Despite his high income, he feels like he’s not well-off. To avoid the £100,000 trap, Murton contributes £19,000 to his pension, reducing his adjusted net income to £99,000. This financial gymnastics allows him to receive £17,100 in government-funded childcare for his two children. Murton argues that the system hasn’t kept pace with rising wages and the cost of living, making it difficult for people like him to make ends meet.
The Tax Trap
Another issue affecting high earners is the tax trap. Anyone earning between £100,000 and £125,140 is taxed at a higher rate than a banker earning millions. This quirk in the British tax system means that some individuals are penalized for earning a higher income. David Johnson, a 52-year-old CEO from Staffordshire, points out that this tax trap is a massive disincentive for staff at his company. He believes that income tax brackets need to be adjusted to take into account wealth disparity with the super-rich.
The Consequences
The £100,000 trap has significant consequences for individuals and families. Some people, like Dave Edgeley, a 35-year-old from Maidenhead, have decided not to have more children due to the financial burden. Edgeley earns £160,000 but cuts his adjusted net income to £95,000 to avoid losing free childcare and paying a 62% marginal tax rate. He and his wife spend £48,000 on childcare fees already and feel that having another child would be too expensive.
A Call for Change
The £100,000 trap highlights the need for a review of the tax system and childcare benefits. The government should consider adjusting income tax brackets and childcare entitlements to ensure that they are fair and equitable. As Johnson points out, high earners are not necessarily wealthy, and the current system can sap ambition and hope. By making changes to the tax system and childcare benefits, the government can help individuals and families make the most of their income and achieve their goals.
Conclusion
The £100,000 trap is a complex issue that affects many individuals and families in the UK. While a pay rise may seem like a positive thing, it can have significant consequences for those who breach the £100,000 threshold. By understanding the childcare trap and the tax trap, individuals can make informed decisions about their finances and plan for the future. Ultimately, the government should consider reforming the tax system and childcare benefits to ensure that they are fair, equitable, and support the well-being of all individuals and families.
