Income tax: despite no raise in rates, people’s worst fears come true

Sarah Coles, head of personal finance at Hargreaves Lansdown, warns that the Budget has delivered the tax change people feared most, as an extended freeze on income tax thresholds drags millions more into higher tax bands — and leaves households facing spiralling tax bills unless they take steps to protect their finances.

Sarah Coles, head of personal finance, Hargreaves Lansdown:

“An income tax hike was the most feared change in the Budget – worrying 16% of people, 20% of Millennials, and 25% of higher rate taxpayers, so the Budget made millions of people’s worst fears a reality.

According to the OBR report, that has been released early by mistake, the government has extended the freeze in the tax thresholds to 2031 – even longer than had been expected. This comes as no surprise, given it has been such an effective stealth tax already. Fiscal drag has hauled over 6 million more people into paying income tax, and 3.36 million more into paying higher or additional rate tax. We’ve had to hand over an extra £89 billion in income tax this year – compared to 2021/22 – as a result. 

It means that every pay rise will mean more people paying more tax, and more tipping over into paying higher rates. Somone earning £50,000 this year will pay £8,165 more in tax over those three years as a result. It’s not just the tax on earnings that’s affected. When you start paying higher rate tax, your personal savings allowance shrinks, from £1,000 for basic rate taxpayers to £500 for higher rate taxpayers, and disappears altogether for additional rate taxpayers. You also pay a higher rate of capital gains tax when you cross into paying higher rate tax, and your dividend tax rate rises as you cross each income band. It means everyone, whatever their income, needs to consider the steps they can take to protect themselves.

What can you do

The best way to protect savings from income tax is to hold them in an ISA. You can protect up to £20,000 in the current tax year. This is particularly valuable for higher earners who have a smaller savings allowance and pay a higher rate on the excess.

To protect against higher rates of capital gains tax and dividend tax after moving tax brackets, it makes sense to invest within a stocks and shares ISA, which are free of both taxes. If you have existing investments outside an ISA and the available allowance, you can use share exchange (bed and ISA) to move them into the ISA and protect them from tax. Take care not to exceed your capital gains tax annual allowance of £3,000 in the process though.

If you’re married or in a civil partnership and your partner pays a lower rate of tax, you can transfer income-producing assets into their name. It means you can both take advantage of your tax allowances. You can also use all the tax-efficient vehicles at your disposal, including your ISAs and pensions, as well as the Junior ISAs and Junior SIPPs of any qualifying children.”