It’s not just 40% – hidden freezes trapping millions of higher rate taxpayers

• There are four thresholds affecting higher rate taxpayers that have fallen significantly behind wage inflation – costing them thousands of pounds.
• The higher rate threshold for income tax is one of them. There are 6.3 million higher rate income taxpayers in the current tax year – up 1.88 million since this threshold was frozen in 2021/2022.
• Wages have risen 22% since this threshold was frozen – but another less well-known threshold has seen wages soar 60% since it was set.

Sarah Coles, head of personal finance, Hargreaves Lansdown:

“The taxman has set an array of sneaky traps for millions of higher rate taxpayers. They’ll be painfully aware of the income tax trap, which has plunged almost 2 million more people into paying higher rate tax since April 2021. However, there are other more stealthy traps ready to catch them and empty their pockets.

When you cross the threshold into paying 40% income tax, you automatically face higher tax rates in all sorts of pockets of your finances – and a lower threshold for savings tax too. Then when you earn a bit more – well before you get anywhere near the additional rate tax threshold – there are a number of horrible tax traps that bite.

The tax attacks

1. Income tax on earnings: You’ll be aware that the higher rate tax threshold has been frozen at £50,270 from April 2021 to April 2028, and your income tax rate will rise from 20% to 40% once you cross the threshold. You might not know that wages have risen 22% since the freeze, and that if the threshold had kept pace with wage inflation it would be £61,329.
2. Losing the personal allowance: Once you earn £100,000, your personal allowance is cut by £1 for every £2 that your adjusted net income* is above this level – until your allowance is zero once you earn £125,140. This is an effective tax rate of 60%. This threshold hasn’t moved since it was introduced in April 2010. Over that time, wages have risen 60%, so to keep pace with wages it would have had to rise to £160,000.
3. High-income child benefit charge: The high-income child benefit charge kicks in at £60,000. If your income (or your partner’s) has pushed over the threshold, and you receive child benefit, you will need to repay at least some of it through self-assessment. Once you earn £80,000 you need to repay it all. However, if you’re not working, claiming child benefit means you qualify for National Insurance credits – which count towards your state pension. So don’t cancel the benefit or avoid claiming it entirely – claim the benefit but waive the payments. 

The charge was introduced in January 2013 at £50,000 – so has risen less than wages, which are up 53% in that time. To keep pace, it would have had to rise to £76,500.

4. Loss of tax-free childcare: This is worth up to £2,000 a year and is available until you earn £100,000, at which point parents no longer qualify. This threshold hasn’t moved since 2017. Over that time wages are up 40%.

Attacks on savings and investments

5. Dividend tax: You’ll pay a higher rate of tax on dividends if you change tax brackets. Basic rate taxpayers pay tax at 8.75% and higher rate taxpayers 33.75%. This increased in April 2022. The tax-free allowance has fallen from £5,000 in 2017/18 to £500 in the current tax year, pushing more people into paying this tax.
6. Capital Gains Tax: You’ll pay a higher rate of CGT after crossing the threshold, and since the Budget, the rate for gains on stocks and shares has risen to 18% for basic rate taxpayers and 24% for higher rate taxpayers.  In the current tax year, you can make gains of £3,000 before paying tax – down from £12,300 in 2022/23.
7. Tax on savings: Savings can be subject to income tax, so if there’s tax to pay it’ll be at a higher rate. You also have a smaller personal savings allowance. Basic rate taxpayers can make £1,000 of interest before worrying about tax, but for higher rate taxpayers this falls to £500. The personal savings allowance hasn’t risen since it was introduced in April 2016

7 end-of-tax year strategies to cut your tax bill.

1. Pay into a pension

Higher rate taxpayers benefit from tax relief at their highest marginal rate. You can pay up to £60,000 into your pension this tax year, and carry forward unused allowances from the previous three tax years.

2. Escape the high-income child benefit charge

The benefit of paying into a pension doesn’t necessarily stop there. It also reduces your adjusted net income*. If you are a parent earning between £60,000 and £80,000, cutting back towards £60,000 means you can reduce your high-income child benefit charge.

3. Use pensions to deal with the £100,000 threshold

If you earn over £100,000, you’ll lose some of your personal allowance. Use a pension to reduce your income, and it will cut the amount of tax you pay at an eye-watering 60%. So, for example, if your income is £101,000 and you pay £1,000 into a pension, you get £400 tax relief, but you also take your income to the £100,000 threshold, so your personal allowance doesn’t taper – saving you another £200 in tax. It means that £1,000 contribution has effectively cost you just £400. Plus, if a parent can bring their income back under £100,000, they may keep their eligibility to tax-free childcare too.

4. Make use of your capital gains tax allowance

If you have investments outside an ISA, it’s worth considering taking advantage of your CGT allowance every tax year. You can use the Bed and ISA process (also known as share exchange) to move these assets into an ISA.  Don’t forget, you can offset any capital losses you make during the tax year against gains. If your total taxable gain is still over the tax-free allowance, you may be able to deduct any unused losses from previous tax years. If just some of your losses reduce your gain to below the tax-free allowance, you can carry forward the remaining losses to a future tax year.

5. Shelter as much of your income-paying assets in ISAs as possible

If you use the Bed and ISA process to shelter income-producing investments in a stocks and shares ISA, you won’t pay tax on dividends in future. Because the rate at which you pay dividend tax rate is often higher than the rate at which you pay capital gains tax, it’s often worth prioritising this when making decisions about how to use your ISA allowance. Meanwhile a cash ISA can protect you from tax on your savings interest.

5. Plan as a couple

If you’re married or in a civil partnership and your partner pays a lower rate of tax, you can transfer income-producing assets into their name. It means you can both take advantage of your tax allowances. You can also use all the tax-efficient vehicles at your disposal, including your ISAs and pensions, as well as the Junior ISAs and Junior SIPPs of any qualifying children.

5. Consider a Venture Capital Trust

These aren’t right for everyone, because they are higher risk, so should only ever be considered as a small part of a large and diverse portfolio. However, if you use these schemes, in addition to the CGT and dividend tax saving, you can get up to 30% income tax relief on the amount you invest – which can reduce your overall tax bill.

* Net adjustable income is your total taxable income before any personal allowances and less certain tax reliefs, including: trading losses, donations made to charities through gift aid, pension contributions paid gross (before tax relief), and pension contributions where your provider has already given you tax relief at the basic rate. It’s complicated, but the key here is you can cut your net adjustable income by making pension contributions.”