A tax cliff is a crunch point that results in  a spike in your marginal rate of income tax. As your taxable income reaches a certain point, you could stand to lose certain benefits which can actually mean you’re getting much less than you expect. While the term ‘cliff’ sounds dramatic – the precipice metaphor in finance can be traced back as far as 1983 –  a better way to think of it might be a gear change in driving; the moment at which higher taxes kick in as you exceed a certain point. As with gear changes, there may often be ways to defer that point; or to navigate it more smoothly.

Knowing where these thresholds are, and how to navigate them, could save you and yours money, and hassle – now, and in the future. 

There are two key tax cliffs for individuals and families in the UK to be aware of.

• £60,000 of income.

It’s also known as the child benefit cliff. At this point, child benefit is gradually withdrawn as the Government begins to levy a Benefit Charge (HICBC), until it is completely withdrawn at around £80,000. You don’t get any warning so this is absolutely something more people need to be aware of.

• £100,000 of income.

It’s also known as the personal allowance cliff. Between £100,000 and £125,140 in income, your personal allowance is reduced by £1 of personal allowance for every £2 of additional income until it’s lost completely.

This means the effective rate of tax on income you earn between £100,000 and £125,140,is 60% for English taxpayers (it can be even higher for Scottish taxpayers). This is higher than the additional rate of tax for those earning above £125,400.

The first question to ask is always: what options do you have to reduce your taxable income ?

If you are in danger of exceeding any of these thresholds, increasing your pension contribution is a great first step. There are several ways to increase your pension contributions such as through an employer pension or through a Self-Invested Pension Plan (SIPP).

If your employer offers Salary Sacrifice, this can be effective in reducing your taxable income, as under this arrangement you give up a portion of your salary in return for another benefit. These benefits usually suffer from tax reliefs and might include, for example, additional pension contributions, car leasing, bikes and charitable giving which have certain tax advantages.

These options are beneficial, as whilst they may reduce your taxable income, the economic impact on your finances will be minimised by the fact that you no longer incur the penalty from the tax cliff. Not only that: doing this is a double win as not only have you planned around the impact of these tax cliffs but also you have received the intended benefit such as funding your pension. 

Whilst not effective for everyone, these benefits can be a valuable opportunity for those looking for a specific outcome. For example, those considering  getting an electric vehicle,  those with regular charitable giving, or those who wanting to cycle to work. We at NatWest cannot advise you on these arrangements, but as ever, the first step should be talk to your HR team and find out what schemes your employer offers – and how to go about making your income more tax-efficient for you. There are only certain benefits a company can offer that have tax incentives, so you need to review your options carefully. 

If your employer doesn’t offer Salary Sacrifice pension options, then you might be able to consider a contribution to a personal pension instead. Contributions to a personal pension are typically made from your net of tax income but tax relief is still received from HMRC. Basic Rate tax relief is received by HMRC topping up your pension directly and further tax relief for higher or additional rate payers is received through self-assessment.

Of course, it’s important to keep in mind that while measures like the above could bring benefits in terms of tax efficiencies overall, reducing your taxable income means you may end up with less immediate pay in your pocket – so depending on your lifestyle’s current priorities, this may be something you need to weigh carefully.  

Let’s take the example of the child benefit cliff. Navigating that successfully goes further than providing a financial helping hand in the long term. One of the lesser-known advantages of child benefit is that it also gives the recipient child-benefit credits towards their state pension.

This was a measure originally designed to protect the parent who gave up work to look after young children, to ensure that they didn’t lose out on their state pension by being a primary-carer parent during their child’s upbringing. Remember, to get the full state pension, need to have worked and contributed for 35 years. To get anything at all, you need to have contributed for 10 years. So by managing the child-benefit tax cliff, you also preserve those credits towards your family’s state pension entitlement.

That’s not always easy, because it’s for either parent in a couple. So if Mum earns £80,000 – even if Dad is not working or earning at all, it still means child benefit will be lost.

What is helpful – and most people don’t realise – is that even if you stop receiving the money because your partner earns too much, you can still claim the National Insurance credit towards your state pension. 

So if your partner is not working but you have children, and you earn more than would qualify to receive child benefit payments, it may be worth looking to your partner to claim the benefit, minus the cash. Because this benefit credit will still count towards their state pension. 

Yes. If you have young children, it can be better from a tax perspective to earn £99,999 than to earn anything up to £138,000 because of the loss of childcare entitlement. However it is also important to consider any wider financial impacts, such as reduced bonus entitlement, mortgage lending, or career opportunity, before giving up income.

So when you get to that position in your career – if you are offered a raise that takes you over the cliff – you should think: ‘How do I reduce my taxable income?’

The answer might be to take the pay rise so that you earn £110,000, but make sure you pay £10,001 into your pension each year – which is provides tax relief.  That way, you’ll be funding a sizeable pension, and you’ll keep getting nursery payments included.

As ever, these are theoretical situations, and managing your own circumstances rewards the amount of thought you put in. For example, if you are already maximising your pension contributions or need the funds today then it might not be appropriate to make a pension contribution.