The £100,000 Personal Allowance Trap Explained

The personal allowance taper is the most expensive tax trap in the UK system for high-earning directors, and it is almost entirely avoidable with the right planning. Once your income exceeds £100,000, HMRC withdraws your personal allowance at a rate of £1 for every £2 above that threshold — creating an effective marginal income tax rate of 60% in the £100,000–£125,140 band.

What is the personal allowance trap?

Everyone in the UK gets a personal allowance — £12,570 for 2026-27 — which shelters that much income from income tax. But once your total income exceeds £100,000, HMRC starts clawing it back: you lose £1 of personal allowance for every £2 of income above £100,000. By the time your income reaches £125,140, the allowance is completely gone.

This taper creates a band of income where you are effectively taxed at 60% on the margin — the worst rate in the UK income tax system, higher even than the 45% additional rate that kicks in above £125,140.

The maths behind the 60% rate

Consider what happens on each additional £2 of income earned between £100,000 and £125,140:

• You pay 40% income tax on that £2 → 80p in tax
• You also lose £1 of personal allowance. That £1 was previously sheltered from tax; now it is taxed at 40% → 40p more in tax
• Total tax on £2 of income: £1.20
• Effective rate: 60%

After the trap band (above £125,140), the effective marginal rate drops back to 45% — the additional rate. So if you earn £126,000, that last £860 is actually taxed at a lower rate than the income between £100,000 and £125,140. The trap band is uniquely punishing.

Worked example: the cost of earning £10,000 extra in the trap band

A director with total income of £105,000 earns an extra £10,000 (additional dividends or a bonus).

• Income tax on £10,000 at 40%: £4,000
• Personal allowance lost: £5,000 (£1 for every £2 above £100k)
• Tax on lost allowance: £5,000 × 40% = £2,000
• Total extra tax: £6,000 on £10,000 of income
• Effective rate: 60%

Who gets caught?

Any director whose salary + dividends + other income lands between £100,000 and £125,140. Common scenarios:

How to escape or avoid the trap

1. Employer pension contributions (most powerful)

An employer pension contribution reduces the company's taxable profit and does not appear as personal income at all. It does not reduce your adjusted net income directly (it's a company expense), but the effect is identical — the profit is removed before it reaches you as dividends.

If your company makes a £25,000 employer pension contribution instead of paying you £25,000 more in dividends, you avoid the entire trap band. At £12,570 salary and £87,430 in dividends, your total income is £100,000 — no taper applies.

Worked example: pension contribution to clear the trap

Director has £130,000 in company profit after salary. Without planning:

• £12,570 salary + £117,430 dividends = £130,000 total income
• Effective tax includes 60% rate on £25,140 of income = severe cost

With a £30,000 employer pension contribution:

• Company profit available for dividends: £130,000 − £30,000 = £100,000
• £12,570 salary + £87,430 dividends = £100,000 total income
• No taper — personal allowance fully intact
• Tax saving from avoiding the trap: approximately £7,542
• Plus corporation tax saving on the pension contribution

2. Gift Aid donations

Gift Aid donations reduce your adjusted net income. A £5,000 Gift Aid donation on £105,000 income reduces adjusted net income to £100,000, restoring £2,500 of personal allowance. The savings are real but the cash must leave your personal funds — unlike employer pension contributions which use company money.

3. Salary sacrifice / personal pension

A personal pension contribution also reduces adjusted net income. The contribution must be made personally (not as an employer contribution), but you claim 20% tax relief at source and can claim the remaining 20% higher rate relief through Self Assessment — effectively reclaiming tax at 40% on pension contributions.

Common mistakes

• Not monitoring income until it's too late — by March, the dividend has already been paid and the pension window may have closed. Monitor quarterly.
• Thinking only salary and dividends count — rental income, interest, freelance income all count toward the £100k threshold. Add everything up.
• Confusing employer and personal pension contributions — employer contributions reduce company profit; personal contributions reduce your adjusted net income. Both work, but via different mechanisms.