Feeling the pinch of tax thresholds creeping around your savings and investments? Little wonder – new research has found some have been frozen for almost half a century at the same level.
These allowances could have been four times higher if they’d kept pace with inflation, according to calculations by investment platform interactive investor.
The inheritance tax annual gifting allowance, for example, – how much you can give away each year without being added to the value of your estate for inheritance tax purposes – has remained at £3,000 since 1981, a grand total of 44 years ago.
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Adjusting this by inflation, this annual exemption should be £11,529 today, a difference of £8,529.
The annual capital gains tax exemption has admittedly increased over the years – rising from £3,000 in 1981 to £12,300 in 2020/21. But since April 2023, it has been cut back down to its early-80s level.
Most heavily punished has been the dividend allowance, the amount you can earn in dividends every year tax free. Once a healthy £5,000 back in 2016, it was slashed to £2,000 the following year and now stands at just £500.
If the dividend allowance had risen with inflation instead of facing swingeing cuts, it would be £6,876 today – almost 14 times higher.
Even tax threshold changes in the last few years are biting due to the recent period of much higher inflation. The income tax higher-rate threshold has been frozen at £50,270 since 2021. Had it increased in-line with inflation, this threshold would be around £62,000 today – a difference of almost £12,000.
Craig Rickman, personal finance expert at interactive investor, said: “Fiscal drag is a sneaky tactic of raising the tax burden over time, as it freezes tax thresholds so that people pay more of their income as wages rise with inflation.
“While it’s not as obvious as raising tax rates directly, it could have a bigger impact over long periods – particularly when you see the length of time that some of these rates have been frozen.”
Which tax threshold has been frozen for the longest?
| Frozen since | Frozen for | Current threshold | Should be (if adjusted by inflation) | Difference |
|---|---|---|---|---|---|
IHT annual gifting allowance | April 1981 | 44 years | £3,000 | £11,529 | £8,529 |
IHT nil rate band | April 2009 | 16 years | £325,000 | £517,007 | £192,007 |
Income tax additional rate threshold | April 2010 | 15 years | £125,140 | £231,000 | £105,860 |
Income tax 60% tax trap | April 2010 | 15 years | £100,000 | £154,789 | £54,789 |
Savings allowance: Basic rate | April 2016 | 9 years | £1,000 | £1,368 | £368 |
Savings allowance: Higher rate | April 2016 | 9 years | £500 | £684 | £184 |
Residence nil rate band | April 2020 | 5 years | £175,000 | £221,633 | £46,633 |
Income tax basic rate threshold | April 2021 | 4 years | £12,570 | £15,517 | £2,947 |
Income tax higher rate threshold | April 2021 | 4 years | £50,270 | £62,059 | £11,789 |
Personal savings allowance halved
Fiscal drag has not gone unnoticed by the Office for Budget Responsibility. In its latest fiscal risks and sustainability report it pointed out 3.5 million more individuals are going to be pulled into the higher-rate tax band of 40% by 2028/29.
The impact is going to be significant on savers, as any basic-rate taxpayer who moves up to the higher-rate tax bracket at 40% will see their personal savings allowance (PSA) halved, from £1,000 worth of savings interest tax-free each year to just £500.
Rachel Springall, finance expert at Moneyfactscompare.co.uk, said: “Savers need to take advantage of their ISA allowance and protect their hard-earned cash from tax. The debate on whether the yearly cash ISA allowance should be cut is ongoing, so savers will no doubt want to maximise their deposits in the meantime.”
In total, there are now just over 8.3 million higher and additional rate taxpayers paying more than the basic income tax rate of 20%. In contrast, that figure stood at just under 5.7 million in 2022/23 when the threshold freeze first applied, an increase of more than 45%. The income tax threshold freeze is set to continue until 2028/29.
Rachael Griffin, tax and financial planning expert at Quilter, said: “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.
“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.”
Inheritance tax band
The nil-rate inheritance tax band has been frozen at £325,000 since 2009 – a core reason why inheritance tax receipts are increasing year on year, as rising asset prices are tipping more estates into IHT territory.
The introduction of the residence nil rate band in 2017 increased the tax-free threshold for many homeowners, but has this allowance not budged for five years.
Also unless you leave your family home to direct descendants, such as children and grandchildren, you don’t qualify for the residence nil rate band, penalising childless couples, and it starts to taper away once your estate exceeds £2 million.
“The combination of frozen tax-free thresholds and the government’s proposed IHT reforms to pensions, farms and businesses, means more estates will face bigger tax bills over the coming years,” said Rickman
60% tax trap
The 60% income tax trap, which happens when your income exceeds £100,000, has also been caught by frozen thresholds.
In this instance, for every £2 of income you earn above £100,000, you lose £1 of your personal allowance – which currently stands at £12,570. This tapering continues until your income reaches £125,140, at which point the entire personal allowance is withdrawn.
This tax threshold has been held for 15 years. In today’s terms, taking inflation into account, it could have moved from £100,000 to just over £150,000.
Rickman added: “It’s always worth remembering that salary sacrifice is a great option for anyone within this salary band. By putting more money into your pension to keep your salary below £100,000, you’re not only avoiding the tax trap – you’re ensuring a better retirement for yourself.”
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