Frozen thresholds drag 7 million into income tax net and 5,000 into IHT

Income tax thresholds have been frozen to the spot since April 2021, and inheritance tax bands since April 2020 – both were three prime ministers ago. These tax rules are set to stay until 2031 – and it’s anyone’s guess how many PMs may come and go in the interim. The number of additional taxpayers created by both freezes is impossible to ignore, and likely to increase further.

In the 2021/22 tax year there were 33 million income taxpayers, and by 2025/26 there were 40 million. It means that as people have received pay rises or inflation-linked pension increases, millions have been dragged into paying tax.

The same phenomenon has also pushed million of people into paying higher rates of tax, as a pay rise pushes them over a threshold into paying income tax at 40% or 45%. Changing tax brackets doesn’t just mean a higher rate of income tax. Once you cross into higher rate tax, your personal savings allowance halves from £1,000 to £500, and you’ll pay 40% on the excess instead of 20%. At the same time, the rate of dividend tax rises from 10.75% to 35.75% and the capital gains tax rate from 18% to 24%. Once you cross into paying additional rate tax, you lose your personal savings allowance and pay 45% on interest and the dividend tax rate rises again to 39.35%.

It means it’s worth considering ways to keep tax to a minimum. You can cut tax on your earnings by boosting pension contributions, which offer tax relief at your highest marginal rate. If your employer offers a salary sacrifice arrangement, you won’t pay any National Insurance on this chunk of your income either. If you make significant interest on savings, a Cash ISA will protect it from income tax. Meanwhile, for investors, a Stocks and shares ISA will protect you from dividend and capital gains tax.

Beyond the allowances, there are tax planning opportunities. If you’re married or in a civil partnership, you can pass assets between you without triggering a tax bill. It means you can both use your allowances for tax-efficient savings and investing. You can also make the most of your savings allowance, dividend allowance and capital gains allowance. If you have too much to shelter from tax and one of you earns less than the other, they can hold more of the balance, so at least some if it is taxed at a lower rate.

Inheritance tax on the rise

Frozen inheritance tax thresholds are also taking a toll. In 2025/26, 32,000 estates were liable for inheritance tax (IHT) at death, up by 5,000 since the inheritance nil rate band and residential nil rate band were first both at their current level in 2020/21. The frozen nil rate bands mean that the increasing value of things like investments, savings and property automatically pushes more people into paying IHT.

However, from next April, the rules are set to get more severe. From that point, pensions will be included in the calculation of the size of your estate, which is estimated to drag another 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.

It’s worth noting that most estates still won’t pay this tax. You have a nil rate band of £325,000, plus a residence nil rate band of £175,000 if you plan to leave your property to children or grandchildren. If you’re married or in a civil partner then when the first of you dies, the survivor may be able to inherit their allowances, so they may have an allowance of £1 million before any tax is due. For a lot of people, that will be enough to protect them.

However, if you think you may end up leaving an inheritance tax problem, then you can reduce your potential bill by making gifts during your life. You have an annual allowance of £3,000 to give away each year. If you didn’t use last year’s allowance you can also carry it forward. On top of that you can make any number of gifts worth up to £250 (although not to anyone getting the annual allowance), and it all falls out of your estate immediately.

You can also give away what’s known as ‘surplus income’, which means as long as the money comes from your income and it doesn’t affect your normal spending, you can give regular gifts that leave your estate straight away too. It’s worth getting to grips with the rules around this, so you know what hoops you need to jump through and records you need to keep. On top of this, you can make bigger one-off gifts, and as long as you live for seven years after giving this money away, it falls out of your estate for inheritance tax purposes.