Frozen tax thresholds are dragging millions more people into higher-rate tax bands, with financial planners urging taxpayers to take action before the end of the tax year to mitigate liability.
Some 7 million will pay higher rate income tax in the current tax year, up 2.6 million since the threshold was frozen in 2021/22. Wages have risen 29% in that period, but the £50,270 threshold has and will remain unchanged until April 2031.
Crossing into the 40% tax band triggers a cascade of additional tax charges. The personal savings allowance halves from £1,000 to £500, dividend tax rises to 33.75% (increasing to 35.75% in April) and capital gains tax on shares jumps to 24%.
Those earning above £60,000 face the high-income child benefit charge (if the income of one parent pushes over the threshold, they will need to repay at least some of the benefit through self-assessment).
For additional-rate payers with an income of more than £100,000, there is a 60% effective tax rate as the personal allowance tapers away.
At this level, the personal allowance is cut by £1 for every £2 earned above £100,000, disappearing entirely once income reaches £125,140. The £100,000 threshold has not moved since April 2010. Had it kept pace with wage inflation, which is up 68% over that period, it would now stand at £168,000.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: "A pay rise is always welcome but over the past few years it has come with a horrible sting in the tail for millions of people, pushing them over the threshold into paying higher rate tax."
Using pensions to reduce liability
The first step to mitigate the tax impact is to use pension contributions. Workers can contribute up to £60,000 into a pension this tax year and carry forward unused allowances from the previous three years.
Higher-rate taxpayers receive tax relief at 40%, with contributions reducing the adjusted net income and potentially bringing earners back below key thresholds. For earners above £100,000, the benefit is even greater: a £1,000 pension contribution costs just £400 after tax relief and the preservation of the personal allowance, which would otherwise taper away.
But the benefits go even further: for parents earning between £60,000 and £80,000, cutting back towards £60,000 means reducing their high-income child benefit charge.
The charge increases on a sliding scale between these thresholds, with full repayment required once income hits £80,000. Parents not working should still claim child benefit even if waiving payments, as this secures National Insurance credits counting towards the state pension.
Additionally, parents who reduce their income below £100,000 through pension contributions may retain eligibility for tax-free childcare, worth up to £2,000 per child annually. This threshold has remained frozen since April 2017, despite wages rising 48%.
ISA strategies and capital gains planning
Investors holding assets outside ISAs should consider using their £3,000 capital gains tax allowance (which has fallen from £12,300 in 2022/23) every tax year and shelter anything that would bring them over the threshold into an ISA.
The Bed and ISA process allows investors to move existing holdings into a tax-efficient wrapper. Dividend-producing investments should be prioritised, as dividend tax rates typically exceed capital gains tax rates for higher earners. The dividend allowance has shrunk from £5,000 in 2017/18 to just £500 in the current tax year.
Cash ISAs can also shelter savings interest from income tax. The personal savings allowance, unchanged since April 2016, gives higher-rate taxpayers just £500 of tax-free interest compared with £1,000 for basic-rate taxpayers. There is no allowance for additional-rate taxpayers.
From 2027, savings will attract even higher tax rates: 22% for basic rate taxpayers, 42% for higher rate and 47% for additional-rate payers.
Investors can offset capital losses made during the tax year against gains. If total taxable gains still exceed the allowance, unused losses from previous years can be deducted. Any remaining losses can be carried forward to future tax years.
Planning as a couple
Married couples and civil partners can transfer income-producing assets to the lower-earning spouse, allowing both to use their full range of allowances. This strategy works particularly well for dividend-paying shares or interest-bearing accounts, as the income is then taxed at the lower earner's marginal rate.
Families should also consider Junior ISAs and Junior SIPPs for children, though contribution limits apply.
Alternative structures
For those with larger portfolios, venture capital trusts (VCTs) offer 30% income-tax relief on investments, alongside capital gains tax and dividend tax exemptions.
However, these are higher-risk investments suitable only for experienced investors with diversified holdings. VCTs should only ever be considered as a small part of a large and diverse portfolio.
From April the tax relief will drop from 30% to 20%, as announced in the autumn Budget, making this the final year that investors can make use of the higher tax saving.