The combination of high inflation and frozen tax thresholds is a toxic mix for taxpayers but provides comforting liquidity for HM Treasury. When the Chancellor announced in his spring 2021 Budget that the UK-wide higher rate tax threshold would be frozen until April 2026 at £50,270, the latest annual CPI inflation reading (for February 2021) was just 0.4%.
At that inflation rate the freeze seemed a tolerable form of stealth tax to help meet pandemic costs. In Scotland, the freeze only applies to savings and dividend income, but the Scottish higher rate threshold for other income (primarily earnings) is lower at £43,662 and the rate 1% higher.
The 2022 Spring Statement saw the Office for Budget Responsibility (OBR) flagging up the effect of much higher inflation on UK taxpayer numbers. Its revised inflation assumptions calculated that the threshold freeze would mean that by 2025/26 there would be 6.8 million higher rate taxpayers – slightly fewer than one in five of all UK income taxpayers and about a third more than in the current tax year. Being a higher rate taxpayer was once membership of a relatively exclusive club, but it is steadily losing that status.
Mitigate the hike
If you are – or will soon be – a higher rate taxpayer, there are plenty of tax planning points you should review with us, including:
- Ensure that you take full advantage of all your tax allowances, such as the dividend allowance and the personal savings allowance, which together could yield a tax saving of £875 in 2022/23.
- Explore the many opportunities presented by independent taxation if you are married or in a civil partnership. For example, rearranging who holds which investments could reduce your joint tax bill. Unmarried partners can do the same, but capital gains tax and inheritance tax liabilities potentially complicate matters.
- Maximise ISA investments – the UK tax freedom of ISAs is more valuable once you pay higher rate tax.
- Review investments – investment returns in the form of capital gains (maximum rate 20% other than for residential property and a £12,300 annual exempt amount) will normally incur much less tax than income.
- If you run your own business, you may have scope to change the way your business is structured or be able to adjust the method by which you extract profits. For example, moving from self-employment to a corporate structure could allow you to draw an income with a lower overall charge to income tax and National Insurance contributions.
- The higher rate of 40% (or 41% in Scotland) income tax also means that you can receive 40%/41% in Scotland on pension contributions. However, you need to watch for the tax traps of the pension annual and lifetime allowances.
Investments do not offer the same level of capital security as deposit accounts. The value of your investment and any income from it can go down as well as up and you may not get back the full amount you invested.
Past performance is not a reliable indicator of future performance.
Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.
The Financial Conduct Authority does not regulate tax advice.
ISA investors do not pay any personal tax on income or gains. Tax treatment varies according to individual circumstances and is subject to change.