23rd June 2022
general
Stealth taxes are usually implemented by freezing the thresholds at which you start to pay tax. As inflation, asset values, and wages increase, keeping tax thresholds stagnant means proportionately more tax is paid relative to typical levels of income and wealth.
So how might stealth taxes affect your financial plan, and what can you do about it?
Income
The personal allowance, or the amount that you can earn free of tax, will be frozen at £12,570 until 2026. Higher and additional rate tax thresholds will also be frozen, at £50,000 and £150,000 respectively. If you earn over £100,000, you start to lose your personal allowance, which results in an effective tax rate of 60% on income between £100,000 and £125,140. This threshold has already been frozen for several years.
While this might not make much difference to your budget year on year, over 5 years it means you will pay significantly more tax. For example, if you earned £12,000 per year in 2021, you would have been a non-taxpayer. However, if inflation increases by 3% per year (currently a modest assumption) and your salary increases accordingly, by 2026 you will be earning almost £14,000. As prices will also have gone up, your earnings won’t have any more buying power, but you will be paying around £400 in extra tax.
The threshold at which child benefit starts to be reclaimed via tax is £50,000. Anyone earning £60,000 or over will pay back this benefit in full. These thresholds have not changed in some time, with no sign of doing so now.
To reduce the impact of stealth income taxes, you can:
Investments
If you earn an income from your savings and investments, you have the following allowances to set against your tax bill:
As these allowances are not changing, and interest rates are set to increase, it is possible that you will pay more tax on your investments.
Additionally, the capital gains tax threshold will also be frozen at £12,300 until 2026. This means that you will probably pay more tax if you sell your investments.
You can reduce tax on your investments by:
Property
Property prices have continued to rise, while stamp duty thresholds have remained the same, with no sign of increasing. The stamp duty holiday in 2021 may have temporarily eased things, but buyers can expect to pay significantly more tax on their property purchases.
Additionally, landlords and second homeowners will continue to pay stamp duty surcharges and capital gains tax, with no changes to the rates or thresholds.
If you need to move home, there is not much you can do, other than stay within your budget, consider moving to a cheaper area, and seek out a competitive deal for your mortgage. Ultimately it might make more sense to improve your current property than move elsewhere.
Property investors can make their affairs more tax-efficient by using a limited company. This can be complex and advice is recommended.
As the tax landscape has become less favourable to property investors, you may want to consider diversifying your portfolio and investing in other asset classes.
Pensions
There are a number of limitations on pension funding:
The current indication is that the lifetime allowance will remain frozen until 2026, with no suggestion of the other allowances changing.
As earnings, pension contributions, and fund values increase, freezing pension allowances can mean that you build up a smaller pension pot. Additionally, if the income tax rate reduces to 19% as planned, basic rate taxpayers will receive less tax relief on their contributions.
To optimise your retirement plan:
Estate Planning
The nil rate band is currently £325,000, and has been frozen for over a decade. This means that anyone with an estate valued above this level (or a couple with assets of over £650,000) will pay 40% tax on the excess.
House prices alone mean that many more families are being impacted by Inheritance Tax (IHT), which at one point, was only a concern for the wealthy. This has been mitigated by the Residence Nil Rate Band, which extends the tax-free amount by up to £175,000 per person when the estate includes a family home.
As there are no increases planned, and estate values will probably continue to rise, the impact of IHT will become even more widespread.
To reduce your IHT liability, you can:
Please don’t hesitate to contact a member of the team to find out more about effective tax planning.