- OBR warns on marginal tax rates and impact on ‘incentives to work, save, and invest’ (Source: OBR – Economic and fiscal outlook – March 2026)
- Further analysis expected to be published in the summer
- Chancellor could come under pressure to address tax cliff-edge, which sees higher earners facing 62% tax and loss of childcare funding
- Pension contributions can help avoid the worst of the income tax trap
Laura Suter, AJ Bell director of personal finance, comments:
“Chancellor Rachel Reeves could come under renewed pressure to address some of the glaring issues with the UK’s tax system, with higher earners in particular suffering from punitive rates of tax that mean working toward a pay rise is hardly worth the effort in many cases.
“The OBR today signalled it plans to scrutinise the tax system for signs that high marginal tax rates are acting as a disincentive for people to progress in work. The most obvious culprit is the absurd cliff-edge in the tax system that sees the marginal rate of tax on earnings reach 62% over £100,000, before falling back to 47% over £125,140. For high-earning graduates with an extra 9% deduction on top the impact is even more stark – meaning on this band of earnings they see 71p for every £1 taken out of their pay packet in tax and loan repayments.
“Likewise, higher rates of income tax north of the border mean Scottish taxpayers face a marginal rate of almost 70p in the pound even before any loan payments are accounted for.
“Parents face a perilous number of cliff edges when it comes to their tax rates. The added effect of the reduction in free hours entitlement alongside the complete removal of any entitlement to the Tax Free Childcare scheme means that households with young children can easily end up significantly worse-off if their pay exceeds £100,000. Lots of parents choose to make extra pension contributions to avoid shooting themselves in the foot financially, while some choose to reduce hours to shrink their earnings.
“Some will argue that the highest earners require less support. But punitive rates of taxation, combined with the immediate withdrawal of childcare funding once you hit a certain earnings level, means people face little or no reward for a promotion or a pay-rise. That’s clearly not a sensible way to encourage growth or incentivise workers to progress or take on new roles.
“The chancellor isn’t solely responsible for the design flaws of the tax system, many of which have been built up over years under different governments to create a patchwork quilt of crazy tax policies. But she does have the power to fix it.”
Tax on earnings over £100,000
“Those earning £100,000 to £125,140 are subject to the highest effective marginal tax rate in the UK, thanks to the loss of their personal allowance.
“Those with salaries up to £125,140 are theoretically taxed at the higher income tax rate of 40%. But that doesn’t paint the full picture. In fact, the withdrawal of the personal allowance means a tax rate of 60% on the band of earnings between £100,000 and £125,140. That rises to 62% when you factor in National Insurance on top.
“It means there’s a strong tax incentive to reduce earnings below £100,000, with parents facing the double-whammy of lost childcare funding too.”
Childcare
“There are three key childcare support payments that parents can claim: tax free childcare; the free hours childcare scheme; and child benefit. While most working couples can access all three, the highest earners are ineligible for almost everything.
“Once one partner earns over £100,000 families are no longer eligible for tax free childcare, worth up to £2,000 per child. Likewise, they can’t use the ‘free’ hours childcare funding which increased in September to 30 hours per week in term time for children from nine months up to three years old. At the same time their access to funding for children aged three to four is slashed from 30 to 15 hours.
“Child benefit is also off limits for anyone earning over £80,000 – and if you do claim the money, you’ll need to repay it thanks to the High Income Child Benefit Charge.
“In total, a family with two children aged nine months and two years old could miss out on over £29,000 this academic year.
“In contrast, families where the main breadwinner earns £60,000 could access all this support, with the figures illustrating how middle-income families have benefitted hugely from government reforms to child benefit and free hours childcare funding in the past couple of years, while the highest earners continue to be excluded.
“The UK tax system operates primarily on individual earnings, not household income. It means these benefits are not available to a family with one partner earning just over £100,000 and another on £20,000, whereas if both parents earn £60,000 each they get the full package of support, giving them a higher family spending power.
Source: AJ Bell. Assumes a family where both parents work and the main breadwinner earns £60,000. Children aged nine months and two years old at the start of each academic year. Based on the national average local authority funding rates for 2024/25 and 2025/26. Child benefit thresholds increased from 6 April 2024.
How pension contributions can help
“Thankfully, there are options for avoiding such a ludicrous penalty on earnings. Diverting money into your pension could leave you in a better overall financial position.
“If you are a high earning parent then paying in just £800 to a pension would lower your adjusted net income by £1,000 (£800 plus automatic basic rate tax relief), potentially getting you back over £27,000 in childcare support and topping up your pension pot by £1,000, too.”
