If your salary has hit six figures, you might think your long-term finances are sorted. But it can be all too easy to fritter away your hard-earned wealth or fall into one of the ‘tax traps’ that hit those earning over £100,000.
While it might be tempting to splurge your extra income on living the high life, some careful planning could mean it has a much longer-lasting impact on your financial wellbeing.
Here are five ways to help make the most of a six-figure salary.
1. Avoid ‘lifestyle inflation’
You might assume that once you’re on a six-figure salary, you’ll have lots of money left at the end of each month. However, our survey1 of 1,200 people earning £100,000+ per year found that 26% of respondents were living pay cheque to pay cheque. While the rising cost of living and higher mortgage costs might be partly to blame – and largely unavoidable – it could also be down to something called ‘lifestyle inflation’.
When people earn more money, the temptation might be to buy more expensive things rather than save the extra cash. These ‘lifestyle upgrades’ could include eating out more often, switching to more expensive branded products, or buying a new car. So while you might be earning more, you don’t actually end up with extra money in your bank account. Over time, lifestyle inflation can translate into stagnant savings and difficulty reaching financial goals.
2. Put your excess income to work
It’s understandable to want to enjoy your higher salary, but using your extra income to save, invest or pay off debts could have a more lasting impact on your financial wellbeing than spending it on short-term luxuries.
If you have expensive debts, such as credit cards or personal loans, it may make sense to focus on paying these off first. This is because the amount of interest charged is likely to be higher than the interest you’re receiving through your savings account. You might also want to consider overpaying on your mortgage. Most mortgage lenders let you overpay by 10% of your outstanding mortgage balance each year without an early repayment fee.
It’s also important to check you have a sufficient ‘rainy day’ fund. Building up at least six months’ worth of essential expenditure in an easy-access savings account could help you pay for unexpected emergencies or cope with a period of unemployment.
Beyond this, investing your excess income in the stock market could give your longer-term finances a boost. Although the stock market is volatile, history shows that equities typically outperform cash and grow above the rate of inflation over long periods.
3. Manage the 60% tax trap
Once you earn over £100,000, you could be paying an effective tax rate of 60% on some of your income. This is because your personal allowance (the amount of income you do not have to pay tax on each year) is tapered once you earn more than £100,000. The personal allowance (currently £12,570) reduces by £1 for every £2 that your adjusted net income exceeds £100,000, and is zero if your income is £125,140 or above. This means that someone earning between £100,000 and £125,140 faces an effective 60% tax rate on that portion of their income (rising to 63% for those in Scotland).
One way to mitigate the 60% tax trap is to save into a pension. If you earn, say, £110,000 and make a gross pension contribution of £10,000, your adjusted net income would fall to £100,000. This would reinstate your personal allowance and give an effective rate of tax relief of 60% on your pension contribution.
4. Beware the childcare ‘cliff edge’
Saving into a pension could also help you avoid the childcare ‘cliff edge’. Once you earn more than £100,000, you lose two parts of childcare support: tax-free childcare and 30 hours of free childcare per week for three- to four-year-olds (due to be extended to children aged from nine months from September 2025). However, if you make pension contributions that reduce your adjusted net income to below £100,000, you could keep your free childcare hours and your tax-free top-ups.
Bear in mind that that there is a cap on the amount you and your employer can pay into your pension each year and still get tax relief. For most people, the pension annual allowance is 100% of your UK relevant earnings or £60,000, whichever is lower (this might be tapered if your adjusted income exceeds £260,000). If you exceed your annual allowance, you’ll have to pay an annual allowance charge which essentially claws back any tax relief received on the excess contribution.
5. Get financial advice
Understanding how to make the most of a six-figure salary – and how different tax rules affect you – isn’t easy. That’s where getting some financial advice comes in. At RBC Brewin Dolphin, we can help you draw up a solid budgeting plan, explain where to save and invest your money for short and long-term goals, and advise on how to make the most of all the tax reliefs and allowances available to you. That way, you can feel more confident that you’re doing the right thing with you money and are on track for a secure financial future.
1 FindOutNow survey of 1,268 people with annual income of £100,000 or more, 25-27 September 2023.
The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
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