In July, Sir Keir Starmer refused to rule out extending the freeze on tax thresholds ahead of the Autumn Budget on 26 November, with many worried about how it will impact their finances.
Which tax thresholds are frozen?
There are tax thresholds which determine when people start paying income tax and NI – and how much they pay.
The basic rate of income tax is 20 per cent, but anyone earning £50,270 to £125,140 per year becomes a higher-rate taxpayer with a 40 per cent tax rate. There is a rate of 45 per cent for additional rate taxpayers earning over £125,140.
The personal allowance falls by £1 for every £2 that your adjusted net income goes above £100,000. The personal allowance is zero if your income is £125,140 or above.
Tax on savings interest: For some people, frozen tax thresholds can have an impact on how much tax they pay on their savings interest.
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Read MoreBasic rate taxpayers can earn £1,000 in tax-free interest each year, while higher-rate taxpayers paying 40 per cent income tax can earn £500 in tax-free interest each year. Additional rate taxpayers earning over £125,140 do not get any PSA.
Scott Gallagher, a director at wealth management firm Rowley Turton, said: “Someone on the cusp of higher rate income tax, with £25,000 on deposit, earning 4 per cent interest, or £1,000 a year, could see a £500 pay rise push them into the higher-rate band.
Sheltering savings in tax-free cash wrappers, ISAs are one option available to savers, but the annual limit is fixed at £20,000.
Any dividend income over £500 is taxable. However, the amount of tax paid varies depending on which income tax threshold people are in. Basic rate taxpayers pay 8.75 per cent, while higher-rate and additional rate taxpayers pay 33.75 per cent and 39.35 per cent respectively. People can be taxed on their dividends at more than one rate.
Once a niche tax affecting a fairly small group of higher earners and business owners, it is now impacting millions of everyday investors, particularly if their salaries breach the threshold for higher or additional income tax.
Why do governments freeze thresholds?
Failing to increase the value of tax thresholds increases people’s taxable income without tax rates actually rising. This results in additional revenue for the government.
This phenomenon, known as fiscal drag, means more taxpayers are ‘dragged’ into paying tax, or paying tax at a higher rate.
While tax thresholds have remained frozen, inflation has increased, leaving people with less disposable income.
The triple lock ensures the state pension increases each year in line with the highest of average earnings, inflation or 2.5 per cent.
The freeze means that the state pension is on track to surpass the personal allowance for the first time in 2027.
Eligible parents can, for example, get tax-free childcare worth up to £2,000 per child per year.
It is possible for people to reduce their total adjusted net income by, for example, adding money to pensions or making charitable donations.
Are frozen tax thresholds affecting behaviour?
Philly Ponniah, a chartered wealth planner and financial coach at Philly Financial, said: “Frozen thresholds are warping behaviour.
“These freezes aren’t just raising revenue without having to announce a tax rise, they’re reshaping how people work, save and plan. The bigger risk is that the government underestimates the damage to economic output.”
She added: “Many people don’t realise that paying into a pension can bring them back below the line, keeping vital benefits while building long-term wealth.”
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