The UK is currently in its second year of a freeze in the “value” of income tax thresholds, which has resulted in an increasing number of people paying higher rates of income tax now or potentially in the future.
The Institute of Fiscal Studies (IFS) have analysed the impact this has and produced a report, “A deepening freeze: more adults than ever are paying higher rate tax”, to highlight the spread of above-basic rate taxpayers using data from HMRC’s personal income data.
We have taken a look at the four main findings from the report:
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The share of adults paying higher rates has increased ‘enormously’ in recent decades.
In 1991/92 only a mere 3.5% of UK adults paid the 40% higher rate of income tax (the then top rate, which had been introduced by Nigel Lawson in 1988). By 2022/23 11% were paying higher rates, a figure set to hit 14% by 2027/28. Of that 14%, 3.1% of adults will face marginal tax rates of either 45% or 60% (due to personal allowance taper), only slightly below the share who paid the 40% higher rate at the start of the 1990s.
2. By 2027/28, more than one in eight nurses and one in four teachers, both groups currently involved in industrial action over pay, are set to be higher rate taxpayers.
In the 1990s, essentially, no nurses and just 5–6% of teachers paid higher rate tax. However, because of income tax thresholds failing to keep up with average wages, both groups are now being dragged into 40% tax.
3. The freeze on income tax thresholds will ultimately represent the single most significant tax increase since Geoffrey Howe increased VAT to 15% in 1979.
The IFS attributes the sharp rise in the number of higher rate taxpayers over the next five years on the Government’s freeze of income tax thresholds. Inflation has turned what was projected to be a relatively modest tax increase, when Rishi Sunak announced his four-year freeze in March 2021, into a massive, and stealthy, revenue raiser.
4. Real household disposable income will be 1.4% lower by 2027/28 thanks to the tax freezes.
Viewed another way, the IFS calculates that real household disposable income would be about 1.4% higher by 2027/28 had the personal allowance and higher rate threshold been increased in line with inflation instead of frozen. The IFS reckons the freeze wipes out around a third of the growth in real household disposable income that households would otherwise have seen over the period of the freeze.
Conclusion and considerations
The report concludes that over the last 40 years, the highest rates of income tax have gone from being a feature of the tax system reserved for only the top few percent, to one that impacts a far more substantial proportion of the population, impacting on jobs traditionally not associated at this level, for instance teachers.
Whilst the above is far from ideal, it does support the view that it is vital for everyone to make sure their financial situation is as tax-efficient as possible. Depending on circumstances, a number of allowances and exemptions are available to help, not limited to but including the following:
ISA Allowances:
Utilising your individual allowance, currently £20,000 for the current tax year, this ensures savings and investments are as tax efficient as possible, as ISAs are not subject to income tax, dividend tax or capital gains tax.
Pension Annual Allowances:
Basic (20%), higher (40%) and additional rate (45%) taxpayers can all receive money from the government based on their income tax position by making pension contributions.
Dividend Allowance and tax rates:
For the current tax year, everyone is able to receive £1,000 of taxable dividends tax-free, any dividends received above this amount will be liable for basic, higher and additional rate tax, however, these tax rates, 8.75% (basic), 33.75% (higher) and 39.35% (additional) are lower than the equivalent income tax rates. Therefore, where possible, it might in the right circumstances, be beneficial to receive income as dividends as opposed to salary
Invest as a couple:
If you’re married or in a civil partnership, you might be able to reduce your dividend tax bill by considering your investments as a couple. For example, if one partner’s income is in a higher tax band, it might make sense to hold income-producing investments in the other partner’s name. Investing as a couple will also ensure you’re making use of each partner’s ISA allowance and dividend allowance.
Tax-relief investments:
There are several investments available which offer the potential to benefit from income tax relief of up to 30% of the initial investment. These investments are classed as high risk (even speculative) due to the underlying investments, and therefore the tax relief is offered in an attempt to offset an element of the associated risks. These types of investment should only be considered by individuals who are comfortable with high levels of investment risk.
As with all types of investments and services available, we continue to consider the suitability of the above to meet our clients’ needs as part of our ongoing service.
Should you wish to receive further information or discuss anything covered in this article, please do not hesitate to contact your Financial Planner who will be more than happy to discuss this with you.
Investment Risk Warning
Please remember the value of your investments and any income from them can go down as well as up and you may get back less than the amount you originally invested. All investments carry an element of risk which may differ significantly. If you are unsure as to the suitability of any particular investment or product, you should seek professional financial advice.
