As the cost of living seems to be rising month by month in the UK, perhaps the last thing you would want to hear is that you may also end up paying more in Income Tax over the next three years.
Unfortunately, this is exactly what some rather concerning research from pensions consultancy firm LCP suggests.
Published in Professional Adviser, LCP’s findings indicate that that an additional 1 million people may have been forced into a higher tax band in 2021/22.
A further 1.5 million could find themselves paying higher-rate Income Tax by the time of the next election in 2024, too, if wages continue to rise at a “relatively rapid” rate over the next three years.
So, find out why this might happen, whether you’ll be squeezed into a higher tax band, and what you could do to reduce your tax bill if you’re set to be affected.
Wage growth and frozen tax allowances
There are two major catalysts that have led LCP to the conclusion that another 2.5 million people will be paying 40% or 45% rates of Income Tax before the end of this parliament.
The first is wage and salary growth over the past two years, as measured by the Office for Budget Responsibility (OBR).
HMRC figures from June 2021 indicated that there were 4.3 million higher- and additional-rate taxpayers in the UK.
Then, using OBR figures that projected wage and salary growth of 2.9% across the 2020/21 and 2021/22 tax years, HMRC estimated this number would reach 4.6 million by 2021/22.
However, in the wake of economic uncertainty over the past year, the OBR has now changed its forecasts for wage and salary growth to over 10% across the same period.
According to LCP, that means there will be 5.2 million higher- and additional-rate taxpayers in 2021/22, an increase of nearly 1 million from June 2021.
Additionally, 1.5 million more workers could see themselves in these higher brackets after freezes to the Income Tax bands, as announced by Rishi Sunak during his spring Budget in March 2021.
The chancellor introduced a range of freezes on tax allowances and thresholds, including the Income Tax bands. That means, until April 2026, the Income Tax bands are fixed at their following levels of:
– 0% for earnings below the Personal Allowance, which stands at up to £12,570
– 20% for basic-rate taxpayers on earnings between £12,571 and £50,270
– 40% for higher-rate taxpayers on earnings between £50,271 and £150,000
– 45% for additional-rate taxpayers on earnings over £150,000.
All in all, this has led LCP to forecast that another three years of rapid wage and salary growth combined with these tax freezes would account for 2.5 million more higher-rate taxpayers by the time of the next general election in 2024.
In the 2010/11 tax year, just 1 in 10 workers was a higher-rate taxpayer. But, according to LCP, this is now set to increase to 1 in 5 workers in 2024/25.
Reducing your Income Tax bill
If you’re already on the boundary of a tax band, you may be concerned that you’re one of these 2.5 million individuals who are projected to pay more Income Tax. You may also be understandably wondering if there’s anything you can do about it.
Below are a few ideas of how you may be able to reduce the effect of moving into a higher Income Tax band on your finances:
Increase your pension contributions
Tax relief on pension contributions is calculated from your marginal rate of Income Tax. So, if a portion of your income is now in the higher-rate bracket, you could make additional pension contributions and benefit from a higher rate of tax relief too.
Bear in mind that you’ll have to claim higher- or additional-rate tax relief on a self-assessment tax return. Additionally, you’ll only receive these higher rates on income that exceeds the tax threshold. The rest of your tax relief will still be applied at the basic rate.
Reduce your take-home pay
For example, if you’re employed you could ask your employer for a salary sacrifice arrangement, receiving less take-home pay in return for other benefits such as increased pension contributions. Alternatively, if you’re a business owner, you could reduce the salary you take from your business and draw it from elsewhere, such as from dividends. In doing so, you would still take home the same amount, but a smaller portion of it would be subject to Income Tax.
Consider other tax-efficient investments
For example, investments in Venture Capital Trusts (VCTs) and companies involved with the Enterprise Investment Scheme (EIS) can come with certain tax advantages, depending on how much you invest.
Bear in mind that both VCTs and EIS investments are in smaller, less-established companies, and so tend to be higher risk. Make sure you’re willing to take on additional risk before you invest.
If you’re unsure which methods will be most appropriate to you, make sure you seek professional financial advice.
Work with us
Of course, arguably the most sensible course of action is to speak to a financial expert.
At Cordiner Wealth, we can help you plan your finances to make them as tax-efficient as possible so that you can make the most of your earnings.
Email firstname.lastname@example.org or call 0113 262 1242 to find out more.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The value of your investment 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.
Enterprise Initiative Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.
Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.
Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.