Like it or not, the freeze on income tax thresholds could mean you could find yourself in a higher tax bracket at some point in the not-too-distant future.
According to estimates from the Office for Budget Responsibility (OBR) around three million more of us could be moved to the higher rate of income taxby 2028-29.
The stealth tax increase will see many households pay thousands more than they would have done had thresholds been indexed in line with inflation.
Shaun Moore, of wealth manager Quilter, said: “Significant wage growth over the last year in a bid to keep pace with inflation will be a double-edged sword for millions of taxpayers who will suddenly find themselves as higher-rate taxpayers.”
Frozen thresholds mean many are unexpectedly crossing into the 40pc higher-rate tax bracket, as the threshold has been stuck at £50,270.
Sarah Coles, of stockbroker Hargreaves Lansdown, said: “Painful traps have been set for millions of people this year. Your pay may not even have kept pace with inflation, but a rise may still have pushed you over a frozen threshold from basic-rate to higher-rate tax.”
Changing tax bands can have a significant knock-on impact on various allowances, triggering higher tax bills.
Telegraph Money explains how much more you could be paying, the steps you should take when you move up a tax bracket – and what you can do to save serious sums of money.
Prepare for a reduced savings allowance
Once you hit the higher-rate income tax threshold, you’ll see the “personal savings allowance” cut in half to £500.
This change means that only the first £500 of your savings interest is tax-free, and any interest earned beyond that is subject to taxation at 40pc.
Mr Moore said: “Given interest rates are currently higher than they have been for many years, lots of people will be getting much more interest on their cash savings. With this mind, it’s important to consider reallocating funds to tax-efficient accounts such as Isas.”
With a generous annual limit of £20,000 per tax year, you can save or invest without having to worry about income tax, capital gains tax, or dividend tax on the returns.
Ms Coles said: “You need to be mindful of the fact that cash Isa rates tend to be slightly lower than their savings accounts equivalents. That said, if you have a large cash holding and are paying tax on your savings interest at 40pc, you may be better off in a cash Isa.”
Another option you might want to consider is purchasing premium bonds, as any prizes you win are completely tax-free.
Plan for higher capital gains tax
One area which is significantly impacted by moving into a higher tax bracket is the treatment of capital gains.
The capital gains tax annual exempt amount has been reduced from £12,300 to £6,000, and is set to fall again from the start of the new tax year (April 6), to £3,000.
Mr Moore said: “This means you have very little to play with. Higher-rate taxpayers face a rate of 20pc on gains from the sale of assets (up from 10pc as a basic-rate taxpayer). And they face 28pc on gains from residential property that isn’t their main residence (up from 18pc).”
But there are steps you can take.
Mr Moore said: “Strategically planning the sale of assets to utilise the annual exemption, and possibly spreading gains over multiple tax years, can be beneficial in reducing your liability. Maximising your Isa allowance remains an excellent way of mitigating CGT for investments.”
Another option involves conducting a “bed and Isa” transaction. This is where you sell assets outside an Isa and then re-purchase them inside the tax wrapper.
Note that it often makes sense to do this anyway, if you have unused CGT allowance, regardless of your tax band.
Get ready for higher dividend rates
You’ll also pay a higher rate of tax on dividends if you change tax brackets.
The dividend tax allowance is currently £1,000, but is about to drop again to £500 in the next tax year.
Mr Moore said: “Any income from dividends is taxed at 33.75pc for higher-rate taxpayers. This compares to just 8.75pc for basic-rate taxpayers.
“Sheltering dividend-paying investments in Isas and pensions becomes of paramount importance.”
Repay child benefit
As a parent, once your earnings go over £50,000 (slightly less than the higher-rate threshold), you will be subject to the “child benefit high income charge”.
Laura Suter, director of personal finance at AJ Bell, said: “This means you lose 1pc of your child benefit payments for every £100 you earn over £50,000.”
If you had two children, you’d be entitled to £2,074.80 a year in child benefit in the current tax year.
Ms Suter added: “For someone with children, a £1,000 pay rise means a 10pc loss in child benefit – which equates to £207. Frustratingly, you can’t just claim the exact percentage of the benefit amount you’re entitled to.”
Instead, you have to be paid the full child benefit and then the Government reclaims half of it by charging you at the end of the tax year.
The key here is to tell HMRC as soon as you realise you’ll face the high income charge. The higher earner in the couple will be responsible for paying the tax charge, or can choose to opt out altogether.
If you decide to receive the benefit and pay the tax charge, you’ll need to fill out a self-assessment tax return – and then pay what you owe.
While there are rumours that the Chancellor, Jeremy Hunt, might make changes to this bizarre aspect of the tax system in the upcoming Budget, for the time being, it’s essential to plan assuming today’s rules will remain in place.
Cancel marriage allowance
If you currently makeuse of the “marriage allowance” and either you or your partner moves up a tax band, you will be required to cancel it.
This tax break is offered by the Government to married couples – as well as those in civil partnerships – and is worth up to £252 a year.
Ms Suter said: “To claim it, one half of the couple must be a basic-rate taxpayer, which means they earn £50,270 or less in the current tax year, and the other half of the couple must earn less than the personal allowance, £12,570 in this tax year.”
If the person claiming it finds their income exceeds the personal allowance, or if the recipient becomes a higher-rate taxpayer, they will no longer be eligible for the tax break.
The marriage allowance must be cancelled by the person who made the claim for it. This can be done using your Government Gateway ID. But what happens if you don’t cancel it?
A spokesman for HMRC, said: “Where the recipient in a marriage allowance claim becomes a higher-rate taxpayer and HMRC are not notified of a cancellation, we will become aware of this at the end-of-year reconciliation.
“At this point, the allowance would end, and the claim will be removed from the beginning of the year. This would generate an underpayment of tax for the recipient of marriage allowance.”
HMRC adds that it is the taxpayer’s responsibility to review their tax code to ensure their estimated income figures are correct and up-to-date. This can be done via your “personal tax account” online.
How to stay below the£50,270threshold
There are steps you can take to keep yourself below the higher-rate tax threshold.
This would mean, for example, that you could go on using the marriage allowance, and that you wouldn’t be subject to the high income child benefit charge.
Becky O’Connor, director of public affairs at PensionBee, said: “If you go into a higher tax bracket, it could be worth considering making additional pension contributions. This not only boosts your pension pot, it can also reduce the amount of tax you pay.”
One way to do this is via a salary sacrifice pension scheme.
Ms O’Connor added: “If you have one of these schemes through work, think about increasing your pension contributions by the amount of the salary increase that you took over the tax threshold.
“Not only can you avoid having to pay the extra income tax you would have faced had your income gone up, but you also benefit from paying lower national insurance contributions – and so does your employer.”
Of course, you have to be willing to forego the extra take-home pay now, but over the long term, this move could save – and make – you money.
Aside from this, another way to cut your tax bill is by making a charitable donation.
Ms Coles said: “The charity will get 20pc in gift aid, and higher-rate taxpayers can claim back the other 20pc through their tax return.
“Admittedly, this won’t leave you better off overall financially, but you will get the benefit of knowing you have donated to a charity you care about.”
...but there are some perks to being a higher-rate payer
While much of the above will make for gloomy reading, it’s not all bad news.
Pension contributions are particularly advantageous for higher-rate taxpayers.
You can receive up to 40pc tax relief on your contributions, making pensions an efficient way to save for retirement. This tax relief presents a great opportunity to reduce your overall tax liability while building your retirement savings.
It means it effectively costs 60p to make a £1 contribution into a pension, compared to 80p for a basic-rate payer.
But what you might not realise is that you may need to claim it.
Ms Suter said: “It depends on the type of pension you’re in. If you make personal contributions to ‘relief-at-source’ schemes [largely Sipp and Isa providers], you’ll need to claim the additional tax relief back from HMRC.
“This might feel like a real admin headache, but you could easily reclaim hundreds – or even thousands – of pounds owed to you.”
To claim your additional tax relief you’ll need to file a tax return. The money will be paid out to you – or offset against your tax bill. You can also claim via the Government Gateway.
Note that you can backdate claims up to four years so, if you realise you should have been claiming in previous years too, make sure to get your claim in as soon as you can before the current tax year ends.
