The pay rise sting: how crossing income thresholds can cost you

The UK tax system is very taxing, and lots of people celebrating a pay rise may later find that the pay boost has a sting in the tail. Once people hit different earnings thresholds they are met with tax cliff edges, allowances being slashed and tax rates jumping – as well as valuable benefits being chopped. 

The situation has become so complex that the Office for Budget Responsibility (OBR) has launched an investigation into the impact that the complicated tax system has on people’s pay and their incentives to work. For many people, once they hit certain thresholds they could lose benefits worth more than their pay rise – which clearly acts as a barrier to progressing at work or taking on that next promotion. 

What’s more, the combination of frozen tax thresholds, reduced tax allowances and rising wages has dragged more people into paying tax. Pensions are your friend in this situation, as paying into a pension can reduce your taxable income and bring you back below many of these thresholds – meaning you either pay lower tax rates or you get back benefits that would have been lost.

£12,570 – starting rate for savings and marriage allowance

If your earnings hit this level there are a few things you need to consider. The first is how your savings are taxed. At the lower end of the scale, the £5,000 starting rate for savings – the additional amount you can receive in cash interest tax free above the personal savings allowance – begins to taper off as soon as earnings go above the £12,570 personal allowance, up to £17,570. Beyond that point, you can earn £1,000 a year in savings interest before being hit with tax, for basic rate taxpayers. If £5,000 of savings interest that was previously tax free now becomes taxable, it could cost you £1,000 a year in tax. 

You may also need to consider the marriage allowance if you are the lower-earning half of a couple. This allowance is lost once you start earning more than £12,570 and become a basic rate taxpayer. In the current year the marriage allowance is worth up to £252 a year. 

£25,000 or £28,470 – student loan threshold

Graduates will be keenly aware of these next thresholds, as it’s the point where they start repaying their loans. For graduates on the plan 2 student loan, once they hit the earnings threshold of £28,470 they will start to pay off their student loan at a rate of 9% of earnings above that amount. From April this year, the threshold increases to £29,385 where it will remain frozen until 2030.

More recent graduates whose courses began in 2023 onwards will pay the same 9% on earnings above a £25,000 threshold from April 2026 – perilously close to the new minimum wage from April. It means that pay rises taking graduates above this level are subject to an effective 37% rate of tax – 20% from income tax, 8% National Insurance and 9% student loan repayment.

£35,000 – winter fuel payment

Hitting this earnings threshold is only relevant for those of state pension age, but it means they could lose a lucrative benefit. 

Among pensioners, those born before 22 September 1959 can receive a winter fuel payment. Generally, a payment of £200 is made to the household if the oldest person is between state pension age and 79, and a payment of £300 is made if the oldest person is 80 or over. Payments may be different if you get pension credit, or certain other benefits. However, if your taxable income goes above £35,000, you will not be able to keep the payment, and HMRC will recover it through the tax system.

£50,270 – higher income, capital gains, savings and dividend tax, and personal savings allowance halved

Once you hit the higher rate of income tax, which is any earnings above £50,270, you hit a bevy of higher taxes and allowance cuts. Not only do you pay 40% income tax on earnings above that threshold, but your personal savings allowance is chopped in half to £500. You are also charged tax on any savings interest above that allowance at your marginal rate, so 40% now you’re a higher rate taxpayer.

Investors with holdings not in an ISA or pension will also face higher rates of capital gains and dividend tax. Both of these have seen the tax-free allowances slashed in recent years, down to £3,000 for capital gains tax from over £12,000 a few years ago, and just £500 for dividend income. This means even those with smaller portfolios could be hit with the tax. 

Once you hit this threshold, you’ll go from paying capital gains tax at a rate of 18% to 24%, which can add up. For example, on a gain of £3,000 above the tax-free threshold this equates to £180 a year in extra tax, or a gain of £15,000 would result an extra £900 in tax. 

Likewise, for dividend income, becoming a higher rate taxpayer means you’ll go from paying 8.75% tax to 33.75% tax. It means that on dividend income of £5,000 you’ll pay an extra £1,250 in tax, or an extra £2,500 in tax on £10,000 of dividend income. It’s worth noting that these rates are set to increase from April to 10.75% and 35.75% for basic rate and higher rate taxpayers respectively.

£60,000 – child benefit clawback

The next threshold where you may lose valuable benefits is £60,000. Once one person in a household earns upwards of £60,000, parents start to lose child benefit as the government claws back 1% of the child benefit you receive for every £200 you earn above £60,000 until it’s wiped out when you earn £80,000 or more. 

Child benefit can add up – it’s worth £1,354.60 a year for one child or £2,251.60 if you have two children. While the loss of this is tapered, it’s a chunky amount to lose.

£100,000 – tax-free childcare cliff edge and tapering of personal allowance

One of the biggest thresholds to hit as you earn more money, when it comes to the tax and benefit impacts, is £100,000 – particularly for parents. The impact of losing childcare support is amplified in England once one parent earns above £100,000, as they lose all entitlement to tax-free childcare, worth up to £2,000 per child per year. At the same time they lose all of the 30 hours funded term time childcare for nine-month to three-year-old children, and half of the 30 hours for children aged between three and four – though different rules apply in Scotland, Wales and Northern Ireland. For parents with multiple young children in nursery, this can have a huge impact on their finances. 

Earnings over this threshold are also simultaneously subject to the personal allowance taper, which means you start to lose the £12,570 tax-free allowance at a rate of £1 for every £2 you earn over £100,000. It means the marginal tax rate between £100,000 and £125,140 is sky high – 60% for most people or 69% if you’re a graduate repaying your student loan. Once you factor in the childcare support being wiped out, for many people in this bracket their take-home pay will reduce as a result of getting a pay rise.

£125,140 – additional rate of income tax and no more personal allowance

Once you’re earning £125,140 or more you completely lose your £12,570 tax-free personal allowance and will be charged a marginal rate of 45% income tax. At this point your savings interest, dividend tax and capital gains tax rates will also rise. On top of this, the personal savings allowance will be cut to zero – meaning you’ll pay a 45% tax rate on all savings income you receive (unless it’s in an ISA or pension).

While typically fewer people might hit this earnings band, with income tax thresholds frozen until 2031 and decent wage growth in recent times, more and more people will be dragged into the additional rate of income tax. Indeed, the latest figures from HMRC suggest that more than 1.2 million people are additional rate taxpayers in 2025/26, up by more than double since the start of the income tax freeze in 2021.

What can people do to avoid going above certain thresholds?

Each of these milestones could hike the amount of tax you pay or reduce your take-home pay, but there are ways to mitigate this. Using pension contributions to lower your adjusted net income can reduce the amount of income tax you pay and therefore rates for other taxes. Sharing finances between married couples can also make the most of allowances available, depending on each of your specific tax circumstances.

When it comes to savings and investments, the best approach to reducing the amount of tax you pay is to move your investments into an ISA or pension, so that any capital gains, dividend income or savings interest is tax free. As long as you have sufficient annual allowance available within a given tax year – up to £20,000 a year for ISAs and usually up to £60,000 a year for pensions – you can continue to stuff more of your money into the accounts. In the case of pensions, this will contribute to lowering your adjusted net income for tax purposes.