The tax-grab pulling more into higher rates

BACK in 1992, only one in every 28 taxpayers paid 40% income tax - by 2028 that figure will reach one in seven.

To make that live a little more, consider that zero nurses and fewer than 6% of teachers paid 40% tax in 1992. By 2028, one in eight nurses and one in four teachers will pay it.

Those figures are from the Institute for Fiscal Studies, which last week published analysis of the government’s recent reform of income tax rates, a move the IFS calculated were “the single most significant tax increase since Geoffrey Howe increased VAT to 15% in 1979”.

You might imagine that a tax rise of that magnitude would have garnered a few more headlines. As it is, most people probably don’t know it’s happening. That’s because it’s happening mostly by stealth - by keeping tax thresholds frozen while wage rises gradually drag more workers into higher rates of tax.

We are now in the second year of a six-year freeze in tax thresholds. The personal allowance when income tax begins to be due (currently £12,570), the higher-rate threshold (currently £50,270) and the additional rate threshold (currently £125,140) will remain where they are until the 2027-28 financial year.

Also frozen is the £100,000 threshold above which individuals see their personal allowance tapered. Once a person hits £100,000 of income, each extra £2 of income results in a loss of £1 from their personal allowance. Once their earnings reach £125,140 they have no personal allowance at all. The effect is that these people pay tax at a rate of 60% on earnings between £100,000 and £125,140. By the IFS’s calculations, the numbers paying this unofficial 60% rate rose fourfold between 2010-11 and 2023-24. 

Compare that situation with 1992, when there was no additional rate at all and no tapering of the personal allowance, and it’s hard to disagree with the IFS conclusions that: “In the space of 40 years, higher rates of income tax will have gone from a feature of the tax system reserved only for the top few percent, to one that impacts a far more substantial proportion of the population, drawing in a sizeable fraction of people working in jobs not typically thought of as very highly paid – such as nurses, teachers and electricians.”

There is little we can do about income tax - but it doesn’t mean there’s nothing we can do. Using earnings to make contributions to a pension is one way to reduce the sum being taken in tax each month. Any contributions you make are boosted with 20% tax relief by the government – and more if you’re a higher or additional rate taxpayer. For example, a £1 contribution today effectively costs you 80p if you’re a basic-rate taxpayer, as little as 60p if you’re a higher-rate taxpayer, or 55p if you pay additional-rate tax.

With your 2023-24 tax year pension allowance you can receive tax relief on contributions up to a maximum of £60,000, capped at the amount you earn if this is less.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.