On 6 April, it will be five years since income tax thresholds were frozen at 2021 levels. Since then, the personal allowance of £12,570 and the higher rate threshold of £50,270 have been stuck at the same level. By the time thresholds rise in April 2031 the income tax system will have been in deepfreeze for a decade.
Tax threshold freeze
Chancellor Rishi Sunak first announced the freeze to the personal allowance – the tax-free earnings limit – and the higher rate threshold at his March 2021 Budget. The freeze was due to hold thresholds at April 2021 levels until 2026, but was subsequently extended to 2028 by Jeremy Hunt.
Rather than raise income tax rates on earnings, Rachel Reeves extended the freeze for a further three years at Budget 2025, turning what began as an unwelcome, but perhaps not unexpected, post-pandemic tax rise into a ten-year freeze that will leave thresholds unchanged from April 6 2021 to April 5 2031.
How much might it cost you?
The freeze could cost basic rate taxpayers up to £700.36 next year, courtesy of the tax-free personal allowance already lost since 2021.
By the time we reach the end of the freeze in 2030/31 that figure will have risen to around £960, although the exact amount will depend on wages and inflation between now and then.
The figures are much worse for higher rate taxpayers. Next year higher rate taxpayers will be paying as much as £3,500 in extra tax. By 2030/31 the higher rate threshold should be approaching £70,000 had it tracked inflation.
One way to illustrate the impact is to consider identical salaries at the start and end of the freeze and compare the income tax bill. A £35,000 salary attracts nearly £4,500 a year in income tax with allowances frozen at 2021 levels, whereas indexed allowances would’ve brought that down to around £3,500 in 2030/31.
Similarly, a £75,000 annual pay packet incurs £17,400 in tax. Were thresholds increased to reflect inflation, the tax bill on £75,000 of income would have dropped to around £12,600 in 2030/31.
Fiscal drag on your finances
When thresholds are frozen, it can drag you into paying more tax as your income rises.
For someone earning £35,000 at the start of the income tax threshold freeze they can expect to be earning around £53,000 in 2030/31 if their pay matches typical wage growth. Under a system of index linked allowanced they could expect to pay a cumulative tax bill of £59,600 during that period. But frozen tax thresholds will cost them approximately £6,500 in extra tax, taking their total tax bill over the period to more than £66,000.
How many people are affected?
Every single taxpayer with earnings over £12,570 is impacted by the freeze, although by exactly how much depends on your income.
That includes those with salaried earnings as well as pensioners receiving taxable income in retirement. It also impacts savers with cash interest that exceeds their combined personal allowance and savings allowance, as well as investors and company directors with dividend income in excess of their personal allowance and dividend allowance – in fact those with dividend income will endure a triple whammy: frozen income tax thresholds; a reduced dividend allowance and now higher tax rates from April.
When the tax threshold policy was first introduced, the Office for Budget Responsibility (OBR) estimated an extra 1.3 million people would be paying tax as a result of the policy and also push 1 million into the 40% tax bracket. The OBR now expects the freeze to force over 6 million people into the income tax system and create 4.8 million more higher rate taxpayers by 2030/31.
Charlene Young: Senior Pensions and Savings Expert
Charlene Young is AJ Bell’s Senior Pensions and Savings Expert. She joined AJ Bell in 2014 from a wealth management firm where she worked with private clients and small businesses as a financial planner.
Charlene...
