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It will impact money going into and coming out of pensions, among other things
Thursday 31 Mar 2022 Author: Laith Khalaf

In his spring statement, chancellor Rishi Sunak unveiled a surprise cut in the income tax rate, to 19%, which will take place from 2024.

That will offer some relief from the frozen income tax thresholds he announced only last year, but a tax tsunami is still about to hit these shores, and it will only exacerbate the cost-of-living crunch that many households will feel this year.

Sunak’s cut in the income tax rate to 19% is somewhat reminiscent of King Canute trying to hold back the tide, except the eleventh-century monarch didn’t cause the waves to lap up on the shore in the first place, and at least he tried to do something about it right away, rather than waiting two years to exercise his powers.

WHAT DOES THE TAX CUT REALLY MEAN?

The income tax cut from 2024 only partially offsets the effects of freezing the income tax allowance, which the chancellor announced last year.

The effect of freezing those allowances, which are very positive for the chancellor at the expense of taxpayers, has been turbo-charged by inflationary pressures.

That’s because if the income tax thresholds weren’t frozen, we’d be expecting them to rise with inflation, though in reality the chancellor might well have baulked at increasing thresholds by 7% or 8%, even if he hadn’t chosen to freeze allowances.

The hypothetical examples below show how the income tax changes introduced since the beginning of 2021 might affect people at three different income levels, over the next five years.

The recent spring statement has taken a little bit of the sting out of things by cutting the income tax rate to 19% from 2024. But across all three income levels, workers are going to pay significantly more income tax than before chancellor stood up at the despatch box last March.

As a result of frozen income tax allowances, millions of people are going to get dragged into the higher tax bands.

Based on OBR forecasts, the personal allowance would reach £15,300 in 2026/27 if uprated in line with CPI inflation but will only sit at £12,800 now it is frozen until 2025/26.

Likewise, if uprated in line with the OBR inflation forecasts, the higher rate threshold would reach £61,200 in 2026/27, but as it is, with thresholds frozen for four years, we can expect it to sit at
just £51,200.

Those who are just below the thresholds currently are likely to feel the sharpest burn, because rising wages are now more likely to push them into a higher tax bracket, seeing as the tax thresholds are going to be standing still.

Based on OBR forecasts for average earnings, we estimate that anyone who is currently earning above £43,600 is now in danger of being dragged into the higher rate tax bracket by wage increases in the next five years.

A rudimentary estimate, based on characteristically out-of-date HMRC figures for the 2019/20 tax year, would put the number of people who now stand to pay some higher rate tax bracket in the next five years, at 2 million.

IMPACT ON PENSIONS

The change in tax rate from 20% to 19% from 2024 is going to mean that the basic rate of tax relief on pension contributions will change too.

To get £100 in a pension, you will need to pay in £81 as a basic rate taxpayer, compared to £80 now.

However, when you think about it, to get that £81 or £80 in your pocket in the first place, in both cases you will have to earn £100 of pre-tax income, because how much you lose to tax is changing, so not much has really changed on that front.

When you draw on your pension, you will also face the lower income tax rate of 19% from 2024, if you are a basic rate taxpayer in retirement. But you will also lose out because the frozen tax thresholds will mean more of your income is exposed to tax, albeit as a slightly lower rate.

Taken on its own, the spring statement was positive for taxpayers, but when combined with the measures announced last year, I’m afraid most of us are still going to find ourselves paying significantly more income tax in the coming years.

There are measures we can take to mitigate higher taxes, such as sensible tax planning and judicious use of tax shelters, so we’re not quite as powerless as Canute when it comes to fighting back the tax tide.

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