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Do frozen tax bands mean you will pay more tax?

In the past tax bands have generally risen in line with inflation but the current landscape offers high inflation and frozen tax bands. As a result more people than ever are falling into higher rates of tax. Peter Webb, our Head of Tax Advisory, takes a look at what action you can take to reduce your exposure.

With tax bands and tax allowances frozen for another year, it’s no surprise that the economic situation is starting to bite. The Institute for Fiscal Studies recently reported that more adults than ever before are now paying tax at higher rates. And with tax bands and allowances set to remain frozen until April 2028, even more people will inevitably be pulled into paying Income Tax at the higher rate of 40% (or even 45%) over the next few years.

According to the Institute, the proportion of people paying higher rate tax has increased significantly since the 1990’s. The research paints a rather grim picture:

  • In 1991-92 only 3.5% of UK taxpayers paid tax at 40%

  • By 2022-23 that figure had increased to 11%

  • By 2027/28 14% will be paying tax at 40% or above

In addition, the report discovered that disposable income will be reduced by 1.4% in real terms by 2028. So with less to spend, many of us will feel a little bit less affluent over the next few years.

Will the Government intervene?

With all that in mind is there any hope that the Government will reduce taxes or reverse their policy of freezing allowances and tax bands? It’s unlikely. In May 2023 Government debt reached more than 100% of annual national income for the first time since 1961. So it doesn’t appear that Rishi Sunak has any scope to cut taxes anytime soon.

Taking action

Given all this is there anything you can do to limit the damage of an increasing tax burden? Aside from looking at ways to economise, it may be that you can also pay less tax.

While all UK tax residents are eligible to make pension contributions, if you have UK taxable earnings you could consider putting more into your UK pension. There are no longer any charges for exceeding the amount of pension savings you can accrue over your lifetime. In fact, from this year the maximum amount you can save into your pension fund each year has been increased from £40K to £60k. Additionally you can carry forward contributions and the significant tax advantages of tax relief, Income and Capital Gains Tax free growth, and, usually Inheritance Tax freedom remains.  As always, actions need to be tailored to your individual circumstances but pensions have a significant role to play in managing the increased tax liability many now face.

Individual Savings Account (ISA)

Another option is to make sure you’re using the Individual Savings Account (ISA) allowances each year. For a family of two adults and two children, ISAs could offer a total of £58,000 of investments each year, with those savings free of Income Tax and Capital Gains Tax. This is particularly relevant given that the dividend allowance has been reduced to £1,000 this year and will drop again to £500 next year, and that the Capital Gains Tax exemption has reduced to £6,000 this year and will be halved to £3,000 next year. As a family of four using the annual ISA allowances each year you could create a £200,000 investment in a vehicle free of Income Tax and Capital Gains Tax.

Lifetime ISA’s

There are also special Lifetime ISAs (LISAs) that help you save for purchasing your first home or retirement and the Government will again top up your savings.

These are just a couple of effective tax planning tools but it’s worth speaking to your financial adviser to explore other ways that you can reduce your tax bill too.

Please contact your nearest office to discuss your own tax planning.