“A growing economy and inflationary pressures have turbo charged the tax revenues the Chancellor is now expecting to harvest from freezing tax thresholds, which he announced in the March Budget. While this is good news for the Exchequer, it means income taxpayers are going to suffer the consequences of Sunak’s stealth tax raid, to the tune of £47 billion over the next five years, according to figures squirreled away in the small print of the Autumn Budget. This is a significant upgrade to the tax revenue forecast in the March Budget, and goes some way to explaining why the Chancellor has so much cash to splash, and why the OBR says the tax burden is going to be the highest since the 1950s.
“Up until 2025/26, the latest figures from the Autumn Budget show the Treasury now expects to receive around £33 billion from freezing income tax thresholds, up from a forecast of £19 billion in March. (The Autumn Budget also provides a forecast for 2026/27 of £13.9 billion, taking the total over the next five years to £47 billion). The big jump in expected tax receipts comes from improved forecasts for wages, and higher inflation expectations, which would have bumped up tax thresholds if the Chancellor hadn’t frozen them.
“Taxpayers can normally expect to lose some of their wage growth to fiscal drag, because earnings tend to rise faster than inflation, and tax thresholds are tethered to the latter. But the move to freeze tax thresholds means taxpayers face fiscal drag on steroids. Wage increases won’t be offset at all by rising tax thresholds, and taxpayers will pay significantly more as a result. It will be difficult to totally avoid the onslaught, but there are legitimate ways to offset extra taxes though tax planning and tax shelters. With dividend tax rates also creeping up next year, wrappers like ISAs and SIPPs can also help to ensure that income from savings and investments isn’t adding to the problem.”
Stealth tax raid examples
The examples below show estimates of what taxpayers might pay in extra taxes as a result of income thresholds being frozen, depending on their income. The figures are based on OBR expectations for inflation and average earnings increases. The figures show that those getting paid around the higher rate threshold (frozen at £50,270) get hit pretty hard, because inflationary increases in the threshold would ordinarily have offered some protection against paying higher rate tax.Income tax payable 2022/23 to 2026/27
|Current income||Frozen thresholds||Inflation-linked thresholds||Additional tax|
Assumptions: Wage growth and inflation rise according to OBR forecasts, income tax rates remain the same, individuals receive no additional income or income tax reliefs
How to beat the stealth tax raid
In the March Budget the Chancellor froze a number of tax allowances until 2025/26, the main ones being the personal tax-free allowance and the higher tax threshold, but the CGT free allowance and IHT allowance were frozen too. Below are some ways consumers can offset some of the tax rises to come.
If you’re a higher rate taxpayer, or become one soon, a pension contribution is a good way to reduce your tax bill. For each £800 you put in, the government adds £200 to your pension. Higher rate taxpayers can then also knock a further £200 of their tax bill, which they would normally pay when they complete their tax return. If you contribute to a workplace pension, chances are your employer will get the extra tax relief applied automatically, you won’t have to claim it.
“The net effect is you get £1,000 in your pension, and it only costs you £600. Your investment growth and income are then tax-free inside the pension, and you can take 25% of your total pot as a tax-free lump sum at retirement. The remaining income your draw is taxable, but in retirement, you’re likely to be paying a lower overall tax rate than when you’re working. The Chancellor did also freeze the pensions Lifetime Allowance at £1,073,100, so if you’re lucky enough to be bumping up against this, you need to think twice before adding more money to your pension.
Stocks and Shares ISAs
You don’t get upfront tax relief on a Stocks and Shares ISA, but your investments grow free from Capital Gains Tax and Income Tax. The Chancellor has frozen the annual amount of gains you can make each year before paying CGT at £12,300 until 2026. The Office for Tax Simplification recommended the Chancellor reduce the allowance to between £2,000 and £4,000, and suggested he should raise the CGT rate, so a frozen allowance is probably a good outcome for investors. But it does mean investors potentially paying more tax on their gains, if their investments aren’t held in a tax shelter like an ISA.
Dividends are also tax-free in an ISA. They are outside an ISA too, but only up to £2,000 a year, which on a portfolio yielding 4% equates to an investment value of £50,000. Even if you’re not there yet, you could well be in future, so it makes sense to protect yourself from dividend tax by making the most of the ISA wrapper. You can contribute up to £20,000 each tax year. That’s particularly the case now frozen allowances are going to mean more people slipping into the higher rate tax bracket. A basic rate taxpayer only pays 7.5% tax on dividends above £2,000 annually, but a higher rate taxpayer pays 32.5%, and an additional rate taxpayer pays 38.1%. These rates are being increase by 1.25% from 2022. So there’s a great saving to be had by keeping your dividend stocks tucked up in an ISA.
Bed and ISA
This is simply funding an ISA using an existing shareholding, but it allows you to sell an investment up to the £12,300 CGT-free gain limit, and buy it straight back within the ISA. So you keep the same investment, but crystallise some tax-free gains, and protect future gains and dividends from tax to boot. If you want to switch out of the investment, you can simply buy a new fund or share in the ISA with the proceeds of the share sale.”
If you’re married or in a civil partnership, you can transfer assets between you without incurring capital gains, which can allow you to use two lots of the £12,300 capital gains tax allowance if you have a large gain to crystallise. That could potentially save you £2,460 in capital gains tax, if you’re a higher rate taxpayer selling shares.
The freezing of the IHT allowance at £325,000 is expected to cost taxpayers around £1 billion over the next five years. Older investors should give IHT ample consideration, it’s not always an easy conversation to have with family, and it’s a difficult tax liability to manage. Although death and taxes are certain, their timing is not. Investing in an AIM portfolio can help minimise inheritance tax liabilities, by investing in qualifying AIM companies which aren’t subject to inheritance tax if you hold them for two years or more. There are managed AIM portfolios out there, or more sophisticated investors can run their own. Investors considering this route should be cognisant of the risks involved in London’s junior market, and weight this part of their portfolio accordingly.
VCT and EIS schemes
Investors who have used up their ISA and pension allowances might consider VCTs and EIS’s to reduce tax liabilities. These invest in very small, often unquoted companies, so risks are high, and liquidity is low. But they do come with notable tax benefits. A VCT comes with 30% up front tax relief on investment up to £200,000 per tax year, but you must hold the investment for at least five years to keep this benefit. Dividends and growth are tax-free. With an EIS, you can also get 30% income tax relief, and defer capital gains. An EIS is normally free from Inheritance Tax after being held for two years too. It’s important not to let the tax tail wag the investment dog though. If an investment looks too risky, or unprofitable, it shouldn’t be taken on just because it saves some tax.
These articles are for information purposes only and are not a personal recommendation or advice.