The amount you pay in tax on your earnings, savings and investments over the past year has increased significantly, absorbing a hefty portion of your wealth. With dividend tax rising this month, and key thresholds still frozen for years, it’s worth considering how to keep the taxman from tucking into even more in the years to come.
Income tax
The profound impact of frozen income tax thresholds is clear. Between the thresholds being frozen at their 2021/22 level up to the 2024/25 tax year, the amount of income tax dragged into the net is up by almost 50%.
It has proven an incredibly effective stealth tax, dipping into our pockets for billions of pounds more in tax every year without the government ever having to announce a rise in the tax rate. To make matters worse, the freeze is now in place until at least 2031, so there’s no end in sight for this relentless stealth tax.
It's not just earnings that are damaged by the freeze. When we cross a threshold, the rate of tax we pay on savings and investments returns rises too – and the allowance for savings falls. It means taxpayers handing over yet more of their investments and savings income and gains to the taxman.
Inheritance tax
The amount of inheritance tax paid has been climbing relentlessly since 2022, which owes a great deal to the decision to freeze the nil rate bands. Rising house prices and investment values have automatically pushed more estates into paying this tax every year, and driven up bills for anyone caught by the net. The inclusion of pensions in people’s estates from April 2027 is expected to drag 10,500 estates into the inheritance tax net that year, hike the amount of tax paid by 38,500 estates and increase the tax due by £34,000 each on average according to HMRC.
Capital gains tax
Capital gains tax has climbed by almost two thirds in a year. It had fallen for two years, in part because people avoided realising gains after the capital gains tax allowance was slashed and the rate was hiked on stocks and shares. It goes to show that if a government cuts an allowance and raises the rate, it can provide people with enough of an incentive to find a way to work around the rules.
Some will be holding on to assets until they die, so they never have to pay the tax, and some will be realising gains gradually. However, others have bitten the bullet and paid the tax in the past 12 months. Capital gains tax is lumpy, with a huge chunk of the gains made by a small number of very large investors. Clearly some of them have hit the wall and paid up in the past 12 months.
10 steps to cut your tax bill
1. Pension contributions attract income tax relief at your highest marginal rate, so are a brilliant way to bring down the amount of tax you pay at higher rates, while boosting your income in retirement.
2. Check if your employer offers a salary sacrifice scheme, which as well as income tax will save you the National Insurance on those contributions too. These schemes are set to get less generous in 2029, but will still be a valuable tool for employees and there’s still time to take advantage.
3. Money saved in a Cash ISA can grow completely free of income tax, so consider the best home for your savings. (Though the Cash ISA limit is set to reduce).
4. Investments within Stocks and Shares ISAs are free of both dividend tax and capital gains tax, so are a sensible place to start.
5. If you have existing investments outside an ISA, you can consider using a Bed and ISA to move up to £20,000 worth into the tax wrapper in the current tax year – assuming you have the allowance available. Though remember sales from a non tax-sheltered account will qualify as disposals for capital gains tax purposes.
6. Take advantage of your capital gains tax annual allowances, realising gains within the £3,000 allowance each year as you go along.
7. If you’re married or in a civil partnership, you can share assets between you without triggering a tax bill, so you can both make full use of your allowances.
8. Consider using your annual inheritance tax gifting allowances to bring down a potential bill.
9. Check whether you can afford to make regular gifts from income, which come out of your estate for inheritance tax purposes immediately.
10. Think about making larger gifts that pass out of your estate for inheritance tax purposes after seven years. However, don’t be in a rush to give away too much, too soon, or you could face a shortfall later in life.
Sarah Coles: Head of Personal Finance
Sarah Coles is AJ Bell’s Head of Personal Finance. She’s passionate about helping people get to grips with their money, so they have more freedom to do the things that really matter to them in...
