Millions are being hit by ‘significant stealth tax’ – will you have to pay more to HMRC?

Almost 32 million people – more than half of all UK adults – could either start paying income tax for the first time, or be dragged into a higher tax band, due to the five-year freeze on income tax thresholds.

Some 17.9 million people may start paying basic-rate tax between 2022-23 and 2027-28 as a result of the freeze on income tax thresholds, a Freedom of Information (FOI) request by the wealth manager Quilter has shown.

A further 12 million could be pulled into the higher-rate tax bracket, meaning they face paying 40% tax on some of their income. Another two million may be dragged into paying additional-rate tax, and be hit with 45% tax, according to the FOI data provided by HMRC.

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“The number of people expected to pay income tax for the first time, or at a higher rate, by 2027/28 is set to rise exponentially due to the continued freeze on tax thresholds,” notes Rachael Griffin, tax and financial planning expert at Quilter.

Income tax bands previously increased with inflation, but they have been frozen since 2022/23 after successive governments chose to keep them static in a bid to raise revenue. As people’s salaries rise, they risk being tipped into a higher tax band, in what is known as “fiscal drag”.

Tax thresholds were initially frozen until 2025-26 in Rishi Sunak’s 2021 Spring Budget, with former chancellor Jeremy Hunt later extending the freeze to April 2028.

In last year’s Autumn Budget, chancellor Rachel Reeves confirmed the income tax threshold freeze would remain in place until 2028.

According to Griffin, if the freeze had ended in 2025-26 as originally planned, the expectation was that 1.3 million more people would be dragged into paying income tax and one million more would pay at the higher 40% rate.

However, Hunt’s extended freeze combined with higher wages is predicted to affect a staggering 31.9 million people in total.

Analysis of the FOI also reveals that 8.2 million of the 17.9 million non-taxpayers pulled into paying income tax are over the age of 60. This suggests that those in receipt of pension income, including the state pension, will increasingly be forced to pay tax on their retirement income for the first time.

“The lengthy freeze is resulting in a significant tax rise by stealth. As incomes rise, including state pension income, more people are being dragged into paying tax for the first time or into higher tax brackets,” comments Griffin.

“Even without an explicit tax rise, the government will continue to collect more from taxpayers each year by keeping thresholds static. What’s more, as the state pension rises while the personal allowance remains stagnant, many pensioners will soon find themselves having to pay back a proportion of their state pension.”

This threat is not only seen by HMRC – the Office for Budget Responsibility (OBR) has also predicted that millions of people will be forced to pay more tax due to frozen thresholds.

According to the OBR’s estimates, an extra 8.3 million people will be affected by fiscal drag between now and the 2029/30 tax year.

In data published alongside the Spring Statement, the budgetary watchdog found that 4.2 million people will start paying income tax for the first time by 2029/30, while a further 4.1 million will be dragged into a higher tax bracket.

This is set to have a large, tangible impact on earners, with interactive investor forecasting that high earners could be as much as £2,445 worse off a year.

The investment platform’s analysis of the OBR’s latest inflation forecast in March found high earners on a £100,000 salary in 2025 would pay £2,445 extra tax each year by April 2028.

Middle earners will also feel the squeeze. Those who have a salary of £35,000 in 2025 are set to pay £845 extra tax each year by April 2028.

Similarly, low earners on a £20,000 salary in 2025 are due to pay £282 extra tax each year by April 2028.

We explain what fiscal drag is, how it affects your finances, the steps you can take to avoid being caught out, and whether the freeze could be extended.

What is fiscal drag?

“Fiscal drag describes the scenario where the tax burden rises behind the scenes as incomes rise but tax bands don’t keep up or remain frozen,” explains Rob Morgan, chief investment analyst at Charles Stanley Direct.

It’s often described as a “stealth tax” because, on the face of it, it doesn’t seem like an additional tax. No bands or percentages change.

However, assuming that wage growth is at least keeping up with inflation (and, at the moment, it is outpacing it), freezing income tax thresholds raises money for the government by bringing more taxpayers into a higher tax bracket, and turning non-taxpayers into basic-rate taxpayers.

“As incomes go up, a larger proportion of earnings falls into higher tax bands,” says Morgan. “A person effectively gets taxed more on the same earnings in terms of its spending power.”

Worryingly, research from Charles Stanley Direct found that 69% of DIY investors don’t understand fiscal drag. This, says Morgan, “could drag people into paying more tax without realising”.

What are the current income tax thresholds?

In England, Wales and Northern Ireland, the income tax thresholds and rates are detailed in the table below.

The tax rate applies to all income earned in each band, so a higher-rate taxpayer will pay the 20% rate on the portion of earnings between £12,571 and £50,270, and 40% on any income above that.

Scotland has a more complex system, based on these bands:

So even though it doesn’t sound like a new tax, freezing income tax thresholds is a tax increase in every meaningful sense of the word. More of your spending power is taxed at a higher level.

Income tax thresholds and savings

The situation becomes more complex if you have significant amounts of savings outside an ISA.

Not only do you pay more tax on savings interest in a higher tax bracket, but your tax-free savings allowance also falls.

On top of that, interest on savings outside an ISA counts towards your income tax calculation.

“A £50,000 salary plus £1,000 savings interest makes you a higher-rate taxpayer, cutting your personal savings allowance to £500 and leaving £500 of interest taxable at 40%,” explains Laura Suter, director of personal finance at AJ Bell.

“The solutions are to use an ISA to shelter savings, pay more into your pension to stay in a lower tax band, or shift savings to a lower-earning partner,” she adds.

The personal savings allowance, which is the amount of interest you can earn on savings tax-free, thresholds are:

Our “ISAs vs savings accounts” guide explains tax on savings in more detail.

Understanding fiscal drag and beating income tax threshold freezes

Fiscal drag isn’t well understood by the general public. Thankfully, there are some simple steps you can take to mitigate its impact.

1. Make pension contributions

Pension contributions receive tax relief, meaning you effectively claw back income tax.

“It means it only costs £80 to pay £100 into your pension for a basic-rate taxpayer and £60 for a higher-rate taxpayer,” says Morgan.

2. Consider salary sacrifice

Making contributions via salary sacrifice, if your employer allows it, can make your income more tax-efficient. Salary sacrifice involves some of your salary going directly into your pension, or towards other benefits such as an electric car, with no tax deducted.

“Through this method you can save on National Insurance as well as income tax, meaning it only costs £68 to pay £100 into your pension for a basic-rate taxpayer, and £58 for a higher-rate taxpayer,” says Morgan. “Our research found that 59% of DIY investors currently use or plan to use salary sacrifice. Of that, 29% say they use salary sacrifice to put them into a lower income tax bracket.”

3. Make use of your ISA allowance

“For investments and savings, using an ISA can shelter your returns from the taxman and ensure you don’t pay unnecessary tax, and if you are a couple with different levels of income, shifting cash or assets to the lower earner can also help minimise tax,” says Morgan.

All adults get a £20,000 ISA allowance each tax year.

Beware of the personal allowance taper

The personal allowance taper affects those whose earnings reach £100,000.

Once this happens, you start to lose your tax-free personal allowance at a rate of £1 for every £2 you earn over the limit. It means the entire allowance is wiped out once you hit £125,140 of earnings. You’re then effectively paying 60% income tax.

Sian Steele, head of tax at wealth management firm Evelyn Partners, warns: “Those approaching or just over the £100,000 income threshold should be aware of potential complexities when considering tax liabilities. Income from savings interest and dividends, for instance, might not be liable to tax itself if it falls within allowances but will count towards adjusted net income and therefore could take someone into the personal allowance taper.”

It can be very tax-efficient to pay cash into your pension to lower your income and escape the personal allowance taper. Once you factor in pension tax relief and any employer matching, there is often very little impact on your take-home pay – and you’ve got the bonus of having more money in your pension pot.

What does fiscal drag mean for the marriage allowance?

If you are in receipt of the marriage allowance, and either you or your partner become a taxpayer or move up a tax band, you will need to cancel it. This will affect spouses and civil partners who are dragged into the basic-rate tax threshold.

Suter explains: “When you become a basic-rate taxpayer you lose the ability to claim the marriage allowance. The marriage allowance is a tax break offered by the government to married couples or those in a civil partnership, and is worth up to £252 a year.

“To claim it one half of the couple must be a basic-rate taxpayer, which means they earn £50,270 or less a year in the current tax year, and the other half of the couple must earn less than the personal allowance, which is £12,570 in this tax year.

“Similarly, if the lower-earning partner finds their income exceeds the personal allowance it means they’ll no longer be able to share it with their spouse via the marriage allowance.”

The person who made the claim for marriage allowance must cancel it, using their Government Gateway ID to process the cancellation.

Could the income tax threshold freeze be extended beyond April 2028?

Frozen income tax bands are currently scheduled to finish in April 2028. However, it may be tempting for Reeves to extend this when she sees how much extra tax revenue it has raised, and because many people don’t understand fiscal drag.

Extending a freeze on tax thresholds may not seem as bad to the general public as increasing the actual rates of income tax, or, say, reducing pension tax relief.

Griffin comments: “During the 2024 Autumn Budget, chancellor Rachel Reeves stated that extending the freeze until 2030 would boost government coffers by billions of pounds. However, she also noted that it would hurt working people and go against Labour’s manifesto commitments, declaring there would be no extension. Instead, from 2028-29, personal tax thresholds would be uprated in line with inflation once again.”

She adds: “Given the challenging fiscal position, there have been rumours that the chancellor might backpedal and opt to freeze income tax thresholds until 2030. However, given the likely backlash and the government’s commitment not to raise taxes for working people, this seems unlikely.”