In his 2021 Spring Budget, the then chancellor Rishi Sunak announced a freeze on the Personal Allowance – the threshold after which Income Tax becomes payable. Intended to run from April 2022 to April 2026, the freeze was later extended to 2028.
The higher-rate Income Tax band (£50,270) was also frozen, while the additional-rate threshold was reduced (to £125,140).
HMRC confirms that the Treasury’s Income Tax receipts have risen in recent years – by more than £23 billion (8.1%) between 2023 and 2024 alone. While HMRC points to growing employment and average earnings as contributing factors, the report also notes the impact of frozen allowances.
In fact, FTAdviser recently suggested that an extended Personal Allowance freeze to 2030 could increase the Income Tax of high earners by more than £7,000. When the 2025 Autumn Budget arrived, chancellor Rachel Reeves surprised many analysts by not only extending the freeze, but doing so until April 2031.
Keep reading to discover how to mitigate the effect of continued freezes and how expert advice can help.
Threshold and allowance freezes are essentially stealth taxes, and fiscal drag could see your tax bill rise
The £7,000 rise in Income Tax mentioned above was based on someone earning £100,000 in 2022, when the freeze began, compared with their potential liability if thresholds had kept pace with inflation. Even with a salary of £80,000, the additional Income Tax bill could reach more than £5,600 by April 2030.
Frozen allowances increase the government’s tax revenues and drag more people into higher tax bands. The Office for Budget Responsibility (OBR) estimates that 3 million more people will pay higher-rate tax by 2028/29, and a further 400,000 will start paying the additional rate.
As a high earner, you could also fall into the so-called “60% tax trap”. This effective marginal rate might apply if your income is between £100,000 and £125,140. Once your earnings exceed £100,000, your Personal Allowance reduces by £2 for every £1 above this amount and disappears once your adjusted net income reaches £125,140 (the frozen threshold for additional-rate Income Tax).
Unbiased reports that the number of high earners affected by this “trap” has risen by 45% in the last two years.
However, Income Tax thresholds aren’t the only ones that are frozen, and fiscal drag could be affecting all aspects of your wealth and finances.
3 areas where fiscal drag could impact your finances and how to mitigate its effects
1. Income Tax
As we have seen, Income Tax thresholds are currently frozen until at least 2031.
Maximising your pension’s tax efficiency could help to lower your bill.
Consider using personal pension contributions, including those made using salary sacrifice – while accounting for the new £2,000 cap, after which employer and employee National Insurance contributions (NICs) will be payable from 2029 – or making charitable donations (ensuring you select Gift Aid) to reduce your adjusted net income. This could reduce Income Tax (or allow you to reclaim more via self-assessment), especially if you are close to certain thresholds, like the £100,000 taper or the additional-rate band.
We have also seen reductions to dividend allowances, making more dividend income taxable.
2. Capital Gains Tax
Rachel Reeves used her 2024 Autumn Budget to increase the tax rates for Capital Gains Tax (CGT). These changes were effective immediately.
Even before these rate rises, however, the Annual Exempt Amount had been significantly reduced – from £12,300 to £6,000 in 2023/24 and then to £3,000 in 2024/25.
These reductions, a form of fiscal drag, could make investments within tax wrappers like Stocks and Shares ISAs increasingly appealing. Gains in a Stocks and Shares ISA are free from CGT and Income Tax.
As a high earner, you might also consider alternative, potentially higher-risk investments like Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS).
There is no CGT to pay on gains held in a VCT for at least three years, or via EIS for at least five years. VCTs offer 30% Income Tax relief on up to £200,000 a year, while EIS funds provide 30% relief on up to £1 million.
The EIS also allows you to postpone paying CGT on the sale of an asset (e.g. property, shares, cryptocurrency) by reinvesting the gain into EIS-qualifying shares – provided the reinvestment is made within the period from one year before to three years after the gain was realised. Of course, there is no guarantee that the CGT rate applicable when the deferred gain becomes taxable will not be higher if legislation changes!
You might also manage a potential CGT bill by transferring assets to your spouse or partner, timing disposals either side of a tax year, or offsetting a sale with losses elsewhere.
3. Inheritance Tax
IHT thresholds – the nil-rate and main residence nil-rate bands – have been frozen for some time.
The nil-rate band was set at £325,000 in 2009/10 and remains at that level for 2025/26. The residence nil-rate band was introduced (at £100,000) in 2017 and has been frozen at its current rate of £175,000 since 2020/21. Both thresholds have now been frozen until 2031.
These freezes have contributed to rising IHT receipts for the Treasury. The OBR expects IHT to top £9.1 billion in 2025/26 as more estates are brought into scope for the tax. Receipts are highly likely to rise again in 2027 as unused pension pots fall into the IHT net.
Lifetime gifts, so-called “giving while living”, could help to tax-efficiently lower the value of your estate, while life insurance policies written in trust can also provide the means to pay off a liability without undue stress on those you leave behind.
Get in touch
If you’d like help managing the effects of fiscal drag on your finances, get in touch. Contact us online or call 020 7400 4700.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients 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.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
