More under-40s set for higher tax brackets

The Labour government may have pledged not to increase income tax but many of us will find more of our earnings going to the taxman in the coming years.

A whopping fifth of under-40s will become higher or additional rate income taxpayers by 2028, new research has revealed. The huge increase in higher-rate taxpayers is down to the freeze on income tax bands.

Back in 2021, the then-Conservative government announced it would freeze the income level at which you start paying income tax as well as the thresholds where your income makes you a higher rate or additional rate taxpayer. The tax thresholds are set to remain frozen until the 2027-28 tax year resulting in inflation and wage growth dragging millions more people into the increased income tax bands.

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Research by Quilter reveals that by 2028 3.6 million workers under 40 will fall into the higher income tax band, thanks to the frozen tax bands. Meanwhile, a further half a million will become additional rate taxpayers.

“Frozen income tax thresholds, which show no signs of thawing under the new Labour government, were initially introduced in the 2021-22 tax year until 2025-26 and were expected to create a total of just one million more higher rate taxpayers in this time,” says Rachael Griffin, tax and financial planning expert at Quilter.

“Now, however, thanks to the extension of the frozen thresholds to the 2027-28 tax year, coupled with higher wages which increased in an attempt to keep up with high inflation, those aged under 40 are expected to more than quadruple the initial target alone.”

What are the income tax bands?

How much income tax you pay depends entirely on how much money you earn.

• Most people get a Personal Allowance of £12,570. We can earn up to that amount each year tax-free. 
• Then you have the basic income tax band. Anything you earn above the Personal Allowance and up to £50,270 will be taxed at the basic income tax rate of 20%. 
• Next is the higher rate tax band. If you earn more than £50,270 a year, then anything above that level will be taxed at 40%. 
• If your annual earnings are over £125,140 you become an additional rate taxpayer with your income over that level taxed at 45%. 
• Once you earn over £100,000 a year you start to gradually lose your Personal Allowance to the point where additional rate taxpayers get no tax-free earnings allowance.

By freezing all the tax thresholds for seven years the Conservative government found a stealthy way to increase income tax. 

Inflation and wage rises mean we all generally earn more as the years go by – usually, the thresholds are increased to reflect this. But holding them at the same level means more and more of us will become higher or additional rate taxpayers thereby increasing the tax revenues.

3 ways to reduce your taxable income

If you are approaching the higher or additional rate tax brackets there are steps you can take to reduce your taxable income and avoid paying a larger income tax bill. 

1. Increase your pension contributions.
This is “particularly advantageous for higher rate taxpayers,” wanting to avoid the additional tax rate, says Griffin. 

You are entitled to 40% tax relief on your pension contributions as a higher-rate taxpayer (you get 20% relief if you are a basic-rate taxpayer). So, saving into a pension can have a double benefit – you get the tax relief added to your pension savings, and you can also reduce your taxable income.

Employees paying into their workplace pension have their contributions taken from their pre-tax income, so increasing the amount you pay into your pension can help keep your taxable income below the next income tax bracket.

“The majority of people can pay up to £60,000 into their pension each year, which can help you reduce your taxable income considerably,” says Griffin. “What’s more, you can carry forward unused pension annual allowance for up to three years.”

2. Use the marriage allowance
Another option for some people will be to use the marriage allowance. If you are married or in a civil partnership and one of you doesn’t earn enough to exceed your Personal Allowance (£12,570) you can give up to 10% of your unused allowance to your partner to reduce their income tax bill. It can shave up to £252 a year off your household income tax bill.

3. Opt for salary sacrifice
“Salary sacrifice is another useful tool that can help save you money on purchases such as protection policies, and in some cases, it can also help reduce your overall tax burden,” says Griffin. 

With salary sacrifice, you lower your taxable income by giving up part of your earnings to receive a non-cash benefit instead such as health insurance, a bike, a company car or increased pension contributions.

“Salary sacrifice is a great way to reduce your tax burden with no extra cost,” says Alice Guy, head of pensions and savings at interactive investor. “Over a lifetime of working, using salary sacrifice can make a big difference to your long-term wealth, especially if you can afford to save or invest your tax savings.”