The dividends and savings interest £100K tax trap

• Workers receiving savings interest and dividends are at risk of being pushed over the £100,000 income threshold, triggering the loss of their personal allowance
• This could also mean losing valuable benefits such as childcare subsidies
• ii calculates that someone earning £100,000 and receiving £5,000 in savings interest would lose £2,500 of their personal allowance, resulting in a tax burden of £2,800
• This compares to£1,800 for a higher-rate taxpayer with adjusted earnings below £100,000
• For £10,000 in savings interest, the burden rises to £5,800
• For dividends, the tax burden is £2,519 for £5,000 and £5,206 for £10,000
• The effective dividend tax rate is 53.75%, combining the higher-rate dividend tax of 33.75% with the 20% effect of the personal allowance taper.

Savings interest

Source: interactive investor - Nb. the marginal tax rate applies to interest income above £500.

Dividends

Source: interactive investor - Nb the marginal rate applies to dividend income above £500.

Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “The quirks of the UK income tax regime mean that additional income from savings interest or dividends, which pushes workers into the £100,000-£125,140 tax band, is taxed at a higher effective rate than for those in the additional-rate tax band.

“This is because additional income within this range is effectively taxed twice: once at your marginal income tax rate and again indirectly, as the tapering of your personal allowance means that additional tax is applied to your income.

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“The £100,000 tax trap doesn’t just hit your wallet with a higher effective tax rate - it can also affect access to key financial support schemes such as 15 and 30 hours free childcare and the Tax-Free Childcare account. Even exceeding the £100,000 threshold by a small amount can result in losing eligibility for these benefits entirely.

“Business owners receiving dividends or individuals who have inherited money, earned bonuses, or gained windfalls through other means could inadvertently breach the £100,000 threshold and face punitive tax rates. Many people in these groups may not be aware of how additional income interacts with the tax system, and without careful tax planning, they risk paying more tax than necessary.”

How to avoid the £100,000 tax trap

Increase pension contributions

Making pension contributions is one of the most effective ways to reduce your adjusted net income (the figure used to calculate your personal allowance). Pension contributions can reduce your adjusted net income, bringing you back under the £100,000 limit. This not only reduces your tax bill but also boosts your retirement savings, with the added benefit of tax relief.

If you make pension contributions through a salary sacrifice scheme, then every £1 contributed will reduce your adjusted net income by the same amount. If you make contributions to a self-invested personal pension (SIPP) as a higher-rate taxpayer, then they will be “grossed up”, further reducing your adjusted net income. For example, £600 contributed will reduce your adjusted net income by £1,000.

Make use of ISAs

Investing in an Individual Savings Account (ISA) shelters any interest, dividends, or gains from tax. Income generated within an ISA doesn’t count towards your taxable income, meaning it won’t push you closer to the £100,000 threshold. The current annual ISA allowance is £20,000 per tax year.

Spread your income

If you have control over how and when you receive income, for example, through a business or investments, you might consider spreading it across tax years or deferring it to stay below the £100,000 limit in a given year. Dividends, for example, could be delayed, or your salary could be structured in a more tax-efficient way.

Consider selling dividend-generating investments

Selling investments that generate dividend income could reduce taxable income and mitigate the impact of the £100,000 tax trap. This strategy allows gains to be taxed under capital gains tax rules instead, with the potential to reinvest proceeds in tax-efficient vehicles such as ISAs or pensions. However, this decision should form part of a broader financial strategy, considering your income needs, tax planning, and investment goals.

Monitor your adjusted net income

Keep a close eye on your adjusted net income to ensure you don’t inadvertently breach the £100,000 threshold. A bonus, additional savings interest, or cashing in taxable investments could unexpectedly push you into the 60% tax band. Simple steps such as making well-timed pension contributions could help you avoid the tax trap.

How savings interest and dividends can push you over the edge

Additional income, such as savings interest or dividends, can push your adjusted net income over the £100,000 threshold, triggering the tapering of your personal allowance and increasing the amount of your income that is taxed at a higher effective marginal tax rate of 60% (40% income tax + 20% from personal allowance reduction).

Our calculations reveal that someone earning £100,000 and receiving £5,000 in savings interest would lose £2,500 of their personal allowance, resulting in an additional £1,000 income tax (£2,500 x 40%) and a tax burden totalling £2,800 (after the £500 personal savings allowance for higher-rate taxpayers is applied).

Although the first £500 of interest is free from income tax, it is still included as part of your adjusted net earnings, reducing your personal allowance.

For £10,000 in savings interest, the tax burden rises to £5,800, compared to £3,800 for a higher-rate taxpayer with adjusted earnings below £100,000. This is because savings income is taxed at your marginal income tax rate, which is 60% in these examples.

The personal allowance is entirely lost once your adjusted net income reaches £125,140, at which point the marginal tax rate reverts to the standard 45% for additional-rate taxpayers. This means someone earning £130,000 would face a lower tax bill of £2,250 on £5,000 in savings interest and £4,500 on £10,000.

The impact of dividends

For dividend income, the tax burden is £2,519 for £5,000 (compared to £1,519 for a higher-rate taxpayer with adjusted earnings below £100,000) and £5,206 for £10,000 (compared to £3,206 for a higher-rate taxpayer with adjusted earnings below £100,000). The calculation accounts for the £1,000 dividend allowance, which reduced to £500 in April 2024. 

In these examples, the effective dividend tax rate is 53.75%, combining the higher-rate dividend tax of 33.75% with the 20% effect of the personal allowance taper.

Once the personal allowance is entirely lost at an adjusted net income of £125,140, the dividend tax rate reverts to the standard 39.35% for additional-rate taxpayers. This means someone earning £130,000 would face a lower tax bill of £1,771 on £5,000 in dividends and £3,738 on £10,000.