When Jeremy Hunt made his spring Budget announcement, tax increases were probably one of the main things you were waiting to hear about. An increase in the rate of Income Tax, for example, can directly affect your wealth and reduce the amount of money in your pocket each month.
So, you may have been pleased to hear that, aside from an increase in Corporation Tax, the rates did not change. But that doesn’t necessarily mean that your tax bill will stay the same in the coming years.
As the old saying goes, there is more than one way to skin a cat and, similarly, there is more than one way to raise taxes. As inflation rises and many tax thresholds remain frozen, it is likely that you may be affected by “stealth taxes” without realising.
That’s because you may move into a higher tax band if your earnings increase but thresholds stay the same. Additionally, some tax-free allowances and annual exempt amounts have reduced, meaning you could end up paying more tax.
Here are five “stealth taxes” you may need to be aware of.
1. Income Tax thresholds are frozen until April 2028
High levels of inflation could be a concern as you notice the costs of goods and services slowly creeping up. But hopefully, as inflation hits 10.1% in the year up to March 2023 according to the Office for National Statistics (ONS), you may also see your earnings increase to keep up with rising costs.
However, even though an earnings increase is normally positive news, it is important to consider the tax implications, because you may also see an increase in your Income Tax bill. That’s because basic- and higher-rate Income Tax thresholds are frozen until April 2028, while the threshold at which you start paying additional-rate tax has been reduced from £150,000 to £125,140.
As your earnings increase while the thresholds stay the same or reduce, you could find yourself pulled into the higher- or additional-rate tax band. This concept is known as “fiscal drag”, and it will likely affect many people in the coming years.
Indeed, according to the Office for Budget Responsibility, fiscal drag could pull an estimated 2.5 million people could into the higher- and additional-rate tax bands by 2028.
This adds up to an estimated £29.3 billion a year increase in tax receipts – the equivalent of a 4p increase in basic-rate income tax.
Fortunately, there are ways to mitigate fiscal drag and potentially combat an increase in your Income Tax bill.
Increasing your pension contributions, for example, is one way to mitigate the effects of this stealth tax if your income now takes you into a higher tax band.
That’s because you can now benefit from a higher rate of tax relief on your contributions – for example, if you now pay 40% higher-rate tax on a portion of your income, you could claim this higher rate of tax relief on any income that exceeds the higher-rate threshold.
So, rather than paying more in tax, you could mitigate this with a pension contribution that allows you to build your retirement savings instead.
2. The High Income Child Benefit Tax Charge is unchanged since 2013
If you claim Child Benefit and earn over £50,000, you will likely be affected by the High Income Child Benefit Tax Charge.
This charge comes into effect when one or both parents have an adjusted net income of over £50,000 a year. If this is the case, you will pay a tax charge equal to 1% of your Child Benefit for every £100 of income over the threshold. So, if you earn £60,000 or more, the tax charge is equal to the total amount of Child Benefit you can receive, effectively negating the benefit.
Unfortunately for parents, the likelihood of paying the charge is growing. That’s because the £50,000 threshold has not increased since its introduction in 2013 even though, according to Royal London, the starting threshold would be over £63,000 as of January 2023 if it had risen in line with inflation. As a result, this tax charge is more likely to affect you.
The threshold for the charge is based on your adjusted net income, which excludes pension contributions. As such, you may benefit from increasing your pension contributions to avoid exceeding annual earnings of £50,000 and triggering the charge.
3. The Personal Savings Allowance remains static in 2023/2024
Compound interest on your savings can help you grow your wealth over time. However, you may want to consider the tax that you are liable to pay on that interest.
The Personal Savings Allowance (PSA), which remains static in 2023/2024, allows basic-rate taxpayers to accrue £1,000 in tax-free interest on their savings, while higher-rate taxpayers can accrue £500. Additional-rate taxpayers must pay tax on all savings interest.
As interest rates rise, the static allowances could push your tax bill up and reduce the returns you see on your cash savings.
In December 2021, the Bank of England base rate was 0.1% but by May 2023, it had risen to 4.5%. While this may mean that you benefit from more interest on your savings – the highest easy access savings account is currently 3.71% according to MoneyFacts – you could lose a larger portion of that interest to tax as the thresholds remain the same.
That’s why you should consider how much wealth you hold in savings accounts and explore other options that may help you combat this stealth tax. A Cash ISA may be a good option, for example, as you do not have to pay tax on any interest you earn on money contained within the ISA “wrapper”.
Alternatively, if you are married or in a civil partnership, you may consider transferring a portion of your savings to your partner. This may allow you to reduce the interest you accrue from a single savings account, meaning that you both remain within the PSA and potentially pay less tax on your savings.
4. IHT “nil-rate bands” frozen until April 2028
When you pass your estate on to your family, they may have to pay Inheritance Tax (IHT) on anything over the “nil-rate band” of £325,000.
Your estate may also be eligible for the £175,000 “residence nil-rate band” if you pass your main residence to your direct descendants, giving you a total of £500,000 you can potentially pass on without an IHT charge.
Now, FTAdviser estimates that if the nil-rate band had increased in line with inflation, it would be over £500,000 by 2028. However, the nil-rate bands are frozen until April 2028, meaning that a larger portion of your estate could be subject to IHT in the future.
There is a strong risk that your estate will increase above the existing thresholds as a result of increasing house values. The Office for National Statistics shows that in the 12 months to February 2023, house prices increased 6% in England, 6.4% in Wales, 1% in Scotland, and 10.2% in Northern Ireland. Your estate could also grow above the threshold as a result of high interest rates which apply to savings or returns from investments.
This means that the overall value of your estate could increase significantly in the coming years, while the nil-rate bands remain the same. As a result, the IHT liability on your estate could well increase.
With effective IHT planning, there are ways that you can reduce the value of your estate, and therefore the amount of IHT payable. However, it usually requires a combination of various solutions, some of which can be very complex. That’s why it is generally best to seek professional advice in this area.
5. Capital Gains Tax annual exempt amount and Dividend Allowance reduced in 2023/2024
When you sell a qualifying asset like stocks and shares not held in an ISA, or a second home, you may have to pay Capital Gains Tax (CGT) on any profits over a given threshold – your CGT annual exempt amount.
This was reduced from £12,300 to £6,000 on 6 April 2023 and is set to halve again to £3,000 in April 2024. As a result, you may be likely to pay significantly more tax when selling certain assets.
Additionally, the Dividend Allowance – the amount you can earn from dividends before paying tax – fell from £2,000 to £1,000 in April 2023 and is set to fall again to £500 in April 2024. This may mean that you pay more tax on profits made from dividends.
Indeed, according to AJ Bell, an additional 1.8 million people may have to pay Dividend Tax for the first time by the 2024/2025 tax year as a result of the change.
If you are concerned about paying more CGT or Dividend Tax, there are some ways to potentially reduce your liability. Firstly, if you are married or in a civil partnership, your partner has their own CGT annual exempt amount, and you can pass assets to them without paying CGT. So, you may be able to transfer assets to them before selling them to make full use of both annual exempt amounts.
Additionally, consider whether you have used your full ISA allowance for the year because assets held in an ISA are not subject to CGT or Dividend Tax. Using this tax wrapper to hold investments may help you mitigate these stealth taxes.
Get in touch
These “stealth taxes” could be eroding your wealth without you realising. Fortunately, we can advise you on ways to potentially mitigate them and help you to make your money as tax-efficient as possible.
Email hello@fcadvice.co.uk or call 0330 828 4714 to find out more today.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
