Personal Tax freeze – The impact of fiscal drag

The Chancellor, Rachel Reeves, has confirmed her plans to extend the Income Tax threshold freeze.

The original end date of 2028 has now moved to the 2030/31 tax year forcing many into higher tax bands as wages rise.

What are the current thresholds?

As it stands, the Income Tax rates are as follows:

• Up to £12,570 = 0 per cent
• £12,571 to £50,270 = 20 per cent
• £50,271 to £125,140 = 40 per cent
• Over £125,140 = 45 per cent

For those with income above £100,000, the personal allowance reduces by £1 for every £2 of income above that level.

By the time income reaches £125,140, the personal allowance is no longer applicable.

What does freezing Income Tax do?

Until 2021, thresholds rose each year roughly in line with inflation, which helped prevent tax bills rising with inflation as incomes increase.

However, the combination of this threshold freeze and rising National Minimum Wage (NMW) and National Living Wage (NLW) means that some taxpayers will find themselves dragged into tax for the first time and others into higher tax brackets.

Over time, take-home pay may grow slowly even if gross pay rises.

Who is affected the most by the Income Tax freeze?

Those earning moderate salaries and getting regular pay rises feel it first.

People on minimum wage or part-time hours who previously paid no tax may begin to pay Income Tax.

Higher earners face quicker erosion of their tax-free allowance and larger portions of their income taxed under higher bands.

Inheritance Tax (IHT) freeze extended

The IHT nil-rate band has also been frozen at £325,000 until 2031, along with the £175,000 residence nil-rate band – a year longer than anticipated.

As property values continue to increase year by year in many UK regions, more estates are likely to be liable for IHT as a result.

What should you do now?

A review of pension contributions can help limit Income Tax exposure. Estate plans should also be revisited to reflect rising asset values and longer-term IHT risk.

Speak to us today to review your personal tax position.