Meg Saksida looks at the impact and practical tips for taxpayers in respect of personal allowances and the additional rate band.
During his Budget speech in March 2021, the Chancellor of the Exchequer, Rishi Sunak, announced that as a part of the various schemes he was introducing to promote economic growth in the UK, both the personal allowance (PA) and the income tax bands would be frozen for the next four years.
Because of the Conservative’s 2019 election manifesto promise not to increase income tax (the ‘tax triple lock’), this freeze was seen to be a good way to address Covid-19 induced UK borrowing without breaking this promise. It has, however, been described as a stealth tax increase.
What are the details?
The PA in 2020/21 was £12,500. The allowance had been consistently increased almost every year previously and had risen by 20% in the preceding five years alone. From April 2022, the PA will rise to £12,570, and it will stay at that level until 2026.
For taxpayers inside the basic rate band, there is a 20% charge to income tax for taxable income up to £37,700. From £37,701 to £150,000, the higher rate band charges income tax at 40%, and for those with taxable income over £150,000, the additional rate band charges taxable income at 45%. These bands remain unchanged from 2021/22 and, like the PA, will be frozen until 2026.
How does this impact taxpayers?
If the taxpayer’s income remains the same, there will be no increase in their taxes. For example, an annual unchanged income of £25,000 will yield £2,486 of annual income tax, and this will remain fixed from 2021/22 right through to 2025/26.
However, with such a freeze, increases in income either through promotion or inflation will not be matched with increases in tax allowances, so many more taxpayers are either pulled into a higher tax bracket or some, who had not needed to pay income tax previously, may in future become taxable at 20%. According to the Institute for Fiscal Studies, this will bring around 1.3 million UK taxpayers into the tax system for the first time.
As the Office for National Statistics shows annual growth in total pay at 7.3% from March to May 2021, many UK taxpayers will be earning more and, therefore, paying more tax per pound of income earned. Taking our taxpayer above, if they now earn (say) £26,000, they will have an extra £200 due in income tax, whereas if the PA had increased with their pay rise to (say) £13,500, their income tax due would be around the same at £2,500. As their salary increase is below inflation, they are not obtaining any more buying power by earning the extra £1,000, but without a corresponding increase in the PA, they will be paying more tax on it.
In addition to the PA and income tax band freezes, the National Insurance contributions thresholds, capital gains tax annual exempt amount, the inheritance tax nil rate band (and residence nil rate band), and the lifetime allowance for pensions have also been frozen.
Practical tips
Taxpayers need to make sure they plan ahead for the next few years.
- Transfers of part of the PA from one spouse or civil partner to the other could increase the donee’s PA to £13,827.
- Due to reductions of the PA of higher earners (over £100,000), contributions to personal pension schemes and donations to charity can secure the full PA.
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Where decisions on the receipt of dividends or wage increases are under the taxpayer’s control, these can be managed and possibly deferred until allowances and bands increase.
