The Conservatives fired the starting gun in the election campaign on personal tax, pledging to uprate the personal allowance for pensioners using a ‘quadruple lock’. This was quickly followed with confirmation that personal tax thresholds and allowances for working people would remain frozen until 2028. Labour has also hinted it would not end the freeze on allowances, nor would it raise tax rates.
IF ALLOWANCES HAD NOT BEEN FROZEN
The OBR estimates that by 2028-29, we will see almost four million extra taxpayers – that is 2.7 million more moved to the higher rate of income tax, and another 600,000 paying the additional rate. These numbers would be a bit lower if the Conservatives won and introduced the quadruple lock for pensioners, but working age people would still be feeling the effects of ‘fiscal drag’.
Most people have a tax-free personal allowance of £12,570, with income tax of 20% payable on the next £37,700, meaning a higher rate threshold of £50,270. If the allowances had increased with inflation, they would be over £15,000 and £60,000 now respectively.
EXTRA TAX PAID
Someone earning £50,000 back in 2021 would expect to be on £67,314 by 2028, according to actual and forecast wage growth figures from the OBR. This would mean they will expect to pay income tax of nearly £80,000 by 2028 with frozen allowances, £14,000 more than they would have likely paid if allowances had been uprated with inflation.
You can see the impact for range of earnings in the table.
WHAT CAN PEOPLE DO ABOUT FROZEN BANDS
For those that can afford to, pension contributions can help lower your adjusted net income and potentially bring you into a lower tax band, with the bonus of boosting your retirement savings.
This is particularly useful for people in ‘tax traps’ created by quirks in the tax system. Examples include the child benefit tax trap for people earning between £60,000 and £80,000 or those who start to lose their tax-free personal allowance and parent who lose all extra childcare funding where adjusted net income is over £100,000.
While improvements have been made to the child benefit thresholds, the adjusted net income limit for losing the personal allowances has been frozen since April 2010.
For example – someone who earns £100,000 and gets a pay rise of £10,000 will pay income tax of £6,000 on that £10,000 – that is 40% on the £10,000 plus another £2,000 thanks to the loss of £5,000 personal allowance.
Factor in lost tax-free childcare for two children (£2,000 each) and the value of free funded hours (around £3,250 a year per preschool child) and that pay rise has lost them more money than it is worth.
By paying £8,000 net into a pension, they will end up with £10,000 extra saved towards retirement thanks to automatic basic rate tax relief, another £2,000 back in higher rate tax relief via self-assessment, plus the value of the extra childcare back.
Disclaimer: Financial services company AJ Bell referenced in the article owns Shares magazine. The author of the article (Charlene Young) and the editor of the article (Tom Sieber) own shares in AJ Bell.
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