An additional 4 million Britons could be paying 40% Income Tax after the chancellor decided to extend the threshold freeze from April 2026 to April 2028. That’s according to the Telegraph, which reported the findings of research by the Centre for Economics and Business Research.
It revealed that an estimated 8 million Britons will be paying 40% Income Tax when the freeze ends. If you’re one of them, it’s not all bad news as there are steps you could take to reduce your Income Tax liability.
Read on to discover three clever actions you might want to consider. First, let’s look at the government’s Income Tax freeze in more detail.
The threshold freeze could increase your tax bill
When he was chancellor, Rishi Sunak froze the Income Tax threshold until April 2026, a move that came into effect in April 2022. His decision meant that the Personal Allowance – which is the amount you can earn before Income Tax is charged – would remain at £12,570 until 2026, and the point at which you become liable to the 40% higher-rate tax would stay at £50,270.
That changed in November 2022, when chancellor Jeremy Hunt announced that the freeze would be extended until April 2028, meaning thresholds would remain static for two more years. As the cost of living has soared in 2022, which means earnings may rise significantly to keep pace, the freeze means more people will be bumped up into the higher-rate tax band.
According to the Financial Times, when Rishi Sunak announced the freeze in March 2021, the Treasury expected it to raise £8 billion a year. With wage increases to keep pace with soaring inflation, the Institute for Fiscal Studies (IFS) has estimated that figure could be £30bn a year by 2026.
Mr Hunt’s extension of the freeze until 2028 could increase the figure further. It’s not all doom and gloom though, as there are ways you could reduce your exposure to the higher-rate of Income Tax if you’ve been snared by the freeze. Let’s consider three options next.
1. Use salary sacrifice schemes
If your employer offers salary sacrifice schemes it could help to reduce your Income Tax liability. Salary sacrifice means that you give up part of your salary in exchange for other benefits, such as increased employer pension contributions or them paying the cost of your daily commute to work.
By reducing your income, you could reduce the amount of Income Tax you pay. If the reduction is enough to drop your earnings to below £50,270, your Income Tax liability would drop to the basic rate of 20%.
While salary sacrifice may sound like a good solution, care must be taken. Reducing your salary could make it more difficult to secure a mortgage and may affect other benefits, such as your death in service.
A financial planner can confirm whether salary sacrifice is right for you or not.
2. Pay yourself with dividends
If you hold dividend-paying investments or are a business owner, you may be able to use dividends to reduce the amount of Income Tax you pay. To do this, you might want to consider paying yourself a salary that is less than the Personal Allowance of £12,570 and use dividends to boost your earnings.
As Dividend Tax is charged at a lower rate than Income Tax, it could reduce your tax liability. In 2022/23, the basic rate of Dividend Tax is 8.75%, the higher rate is 33.75% and the additional rate increased to 39.35%.
This compares to Income Tax rates of 20%, 40% and 45% respectively. That said, you should also note that in November 2022 the chancellor announced that the Dividend Tax allowance of £2,000 would drop to £1,000 in April 2023, and then fall to £500 in 2024.
A financial planner will be able to confirm whether using dividends as an income is the right strategy for you, as doing so may affect the tax relief you receive on pension contributions.
3. Increase personal pension contributions
The contributions you make to your pension typically benefit from tax relief. This is because the government effectively gives you back the tax you paid on your pension contributions and puts it into your pension pot.
As a result, every £100 you place into your pension only costs you £80 as a basic-rate taxpayer. If you’re a higher-rate taxpayer you will usually pay just £60, and additional-rate taxpayers may only pay £55.
While you’re allowed to contribute as much money as you like into your pension, the amount that receives tax relief is limited to your Annual Allowance. In 2022/23, this is typically the amount you earn or £40,000 a year, whichever is the lower.
If you are a high earner, your Annual Allowance may be reduced to just £4,000.
Please note that while tax relief is available at your highest marginal rate, HM Revenue & Customs only returns the basic-rate of 20% back to your pension provider automatically. This means that if you are a higher-rate or additional-rate taxpayer, you will need to claim the remaining 20% or 25% via self-assessment.
A financial planner can help you claim the additional tax relief using self-assessment.
Get in touch
If you have been pushed up into the higher-rate tax bracket, or fear you will be in the future, please contact us to discuss how you might be able to lower your Income Tax liability.
You can email us on hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that we will provide excellent advice and high quality service.
Please note
This blog is for general information only and does not constitute advice. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The information is aimed at retail clients only.
