Nobody is ever happy to hear from the tax man. Still, with Chancellor of the Exchequer Rachel Reeves opting to continue the income tax threshold freeze imposed by the Conservatives in 2022 until 2028, we may face higher taxes in the near future.
While Reeves was keen to confirm that extending thresholds was off the table in Labour’s Autumn Budget back in October 2024, the freeze is likely to be a key source of financial difficulties for UK households in the years to come.
The biggest issue stemming from the tax threshold freeze is that the fixed rates based on individual income bands will remain in place even as workers experience salary increases, pushing millions into paying higher taxes.
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How Worse Off Will Taxpayers Be?
According to an analysis from The Resolution Foundation, taxpayers are set to pay £40 billion more per year by 2028 as a result of the personal tax threshold freeze and inflation. As a result, the freeze would amount to the biggest tax rise in the UK for at least 50 years.
For the 2024/25 tax year, if you live in England, Wales, or Northern Ireland, three tax income bands determine how much you pay the tax man. There’s the 20% basic rate of tax, the 40% higher rate, and an additional 45% additional rate. It’s also worth keeping in mind that personal tax allowances shrink if your earnings hit £100,000.
These marginal bands apply to the proportion of your salary that extends into each tax bracket. In practice, this means that if your salary puts you in the higher 40% tax bracket, then you only pay 40% tax on the segment of earnings inside that tax band.
While this means that you’ll still pay 20% and 0% tax for the proportion of the lower part of your earnings, your wage increases between now and 2028 will mean that you’re liable to pay 40% on a higher proportion of your salary if it extends further into the higher rate.
This isn’t the case in Scotland, however, which has six marginal income tax bands starting at 19%. Other bands include the 20% basic rate, 21% intermediate rate, 42% higher rate, a new 45% advance rate, and the top 48% rate.
Historically high inflation rates have also played a role in hitting us with higher future tax bills. With consumer prices increasing alongside the cost of living, we’re seeing more employers increase their rate of pay rises to help support workers.
With tax bands set to remain the same for the next three years, inflation means that we will see a higher proportion of workers dragged into the higher tax band in a process known as ‘fiscal drag’.
The tax threshold freeze was estimated to raise £30 billion by the 2027/28 tax year, according to the Resolution Foundation. However, with inflation forecasts in mind, this figure could accelerate to £40 billion per year.
How UK Residents Protect Their Savings?
Although the tax threshold freeze is set to impact lots of UK residents, there are a number of measures you can take to help mitigate the impact of paying higher taxes in the years to come.
The following considerations can be an effective way of protecting your wealth while easing the burden of entering a higher tax band in the near future:
Take Advantage of ISA Tax Allowances
Investing your money in an individual savings account, or ISA for short, is an excellent way to protect your wealth against the prospect of higher taxation.
Whether you choose a Cash ISA or a Stocks and Shares ISA, these savings accounts are tax-efficient and you’re allowed to save up to £20,000 during each tax year without having to pay any tax on your savings.
Stocks and Shares ISAs are a great way to invest tax-free to help mitigate the impact of paying higher tax rates on your income, and during a high inflation environment, the ability for your investments to grow over time with the help of a competent account manager can pay dividends in allowing you to build your wealth.
Build Your Pension Contributions
Investing in a pension is another highly tax-efficient approach when it comes to building your wealth.
If you’re a higher-rate taxpayer who puts 100% of your earnings into a pension, you’ll be eligible for an additional 20% tax relief on top of the basic 20% tax relief claimed by your pension provider, amounting to a total saving of 40%.
This 40% saving is applicable to workplace and personal pensions, but you can claim the additional relief via your self-assessment tax form.
If you’re employed, any increases to your pension contributions mean that your employer will increase their contribution too, helping you to compound your savings. However, it’s important to bear in mind that investing in a pension means that you’ll only be able to reap the rewards of your savings at retirement age, which is currently set at 55 but will increase to 57 from 6th April 2028.
Getting The Most From Your Allowances
Because every UK resident has a personal tax allowance of £12,570, it’s possible to make this work to your advantage.
Making the most of your tax allowances is important, and you can shift your income or create shared allowances with your spouse to spread your earnings across a lower tax band. For married couples or civil partners, for instance, it’s possible to transfer portions of your personal allowance to one another, growing your tax-free income.
It’s worth looking at marriage allowance and savings income allowance to improve your tax efficiency and minimise the amount of tax you’re liable to pay.
Getting Tax Savvy
The government’s freeze on tax thresholds is likely to become a major problem for UK households in the years to come as wage increases continually push workers into higher tax bands. However, there are several measures that you can take to improve your overall tax efficiency.
From exploring ISAs to making the most of your tax allowances, you can navigate your tax thresholds to mitigate any damage done if you move into a higher tax band in the coming years.
By taking the time to explore which tax-efficient savings strategy best suits your needs, you can create a sustainable approach to fending off the tax man and protecting your wealth over the long term.
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