Millions to become higher rate taxpayers – will you be one?

In the 2022 Spring Statement, then Chancellor Rishi Sunak froze the Income Tax personal allowance. The allowance currently stands at £12,570 and will remain so until the end of the 2025/6 tax year. This is essentially a real-terms cut. Add in fast wage growth – fuelled by a rapid increase in inflation – and millions of people will find they’ve become higher rate taxpayers.

Moving forward to today, with the energy and cost of living crisis, this is proving major blow to household incomes. Rampant inflation means that pay is worth less. Yet, any pay rise that pushes income over £50,270 will mean anything over that figure is taxed at 40%, not 20%. In this article, we’ll take a look at how many people will be affected – and what you can do about it.

How many extra higher rate taxpayers will there be?

In short, there will be millions of new higher rate taxpayers. House of Commons Library figures estimate that an extra 1.2 million people will be sucked into the higher tax band by 2026. An FT Adviser article quotes an estimate that 2.5 million people will have been brought into the upper band during the period 2019 to 2024/5.

Why will so many people pay higher taxes? 

The real driver will be the growth in wages. Every March, the Office of Budgetary Responsibility (OBR) publishes its Economic and Fiscal Outlook Report. In its 2021 report, it predicted the following percentage growth of salaries compared the previous year.

Since then, a host of factors – not least the war in Ukraine – have made a significant impact on the economy. Inflation has rocketed and the OBR’s 2022 report predicts that wages and salaries are poised to grow much faster. These are the revised figures.

Originally, HMRC thought that an extra 300,000 people would have become higher rate taxpayers by 2021/22. This figure is now likely to be just under a million.

What can I do to avoid becoming a higher rate taxpayer?

If you are likely to be pushed into the higher rate threshold, it’s a good idea to plan your strategy in advance. That’s why we strongly recommend talking to a THP specialist about tax planning.

The strategy you adopt will depend on your personal circumstances. However, one common approach is to save extra money into your pension. Doing so reduces your salary for income tax purposes and it could bring you back down into the basic rate tax band.

This is fine if you can afford to lock the extra money up in your pension. Though it’s worth remembering you’ll be bringing home less money at a time when prices are soaring.

However, there are other ways you may be able to get yourself back into the basic rate tax bracket. For example, a salary sacrifice scheme can work if you’re not too far over the threshold. Essentially, you give up some of your salary in exchange for a benefit such as a company car or increased employer’s pension contributions.

Other options include gifting to charity (this can make the higher rate tax ‘kick in’ at a slightly higher threshold), or certain tax-efficient investment schemes.

So, if it looks like you’re about to become one of the millions of extra higher rate taxpayers, you need to make a decision. Do you just accept it, or do you find a way of making your money work a bit smarter? If you decide on the latter, get in touch – our tax specialists are here to help you.