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More than 1mn UK taxpayers will experience an income “tax sting” by 2027-28 where they lose their tax-free personal allowance and face a marginal rate of 60 per cent, according to official data.
In response to a freedom of information request, seen by the Financial Times, HM Revenue & Customs revealed the number of people losing all of their personal allowance, currently £12,570, will top 1mn for the first time in 2027-28.
Since 2010, those earning more than £100,000 a year have had their personal allowance tapered away. This means that for every £2 earned above the £100,000 threshold, £1 of the allowance is removed.
HMRC figures showed that in the current 2024-25 year, 885,000 people have lost all of their personal allowance, while a further 591,000 have lost part of it.
The tax-free personal allowance has been frozen at £12,570 since April 2021 and the previous government committed to keep this in place until 2028. But chancellor Rachel Reeves is expected to extend the freeze at the Budget on October 30, government officials told the Financial Times last week.
Sean McCann, chartered financial planner at NFU Mutual, an advisory firm which made the FOI request, said that if the £100,000 threshold had risen in line with inflation it would now be worth £149,000.
“Fiscal drag is a great way to raise more revenue, while sticking to [Labour’s] promise of not increasing tax rates,” he said.
Fiscal drag refers to where thresholds do not rise in line with inflation and as a result more people find themselves in higher tax brackets as they get pay increases.
The effect of this measure was “painful”, McCann said. “If you’re earning more than £100,000, it does come with quite a tax sting as you face a 60 per cent tax on those earnings.”
“For every £2 of income over £100,000, £1 of the tax-free allowance is lost — which means this tax year, earnings between £100,000 and £125,140 are in effect taxed at 60 per cent,” he added.
“When you add in national insurance of 2 per cent this means that only £38 of every £100 earned between these amounts ends up in the employee’s pocket.”
McCann expects Reeves to extend the frozen thresholds past 2028 and warned this would lead to even more people being caught out by the 60 per cent marginal rate.
Chris Etherington, partner at accounting firm RSM UK, agreed that the chancellor would face a “strong temptation to raise taxes by the back door”.
However, he said the revenue benefits of freezing thresholds longer “may not be as great” as under the previous Conservative government, given the lower inflationary environment the country had now entered.
McCann pointed out that there are various ways those facing a 60 per cent tax rate can structure their affairs to mitigate the impact, including making use of salary sacrifice and charitable giving.
“Salary sacrifice can be a very tax efficient way to save,” he said. “An employee with earnings of £125,140 who sacrificed £25,140 in return for an employer pension contribution of the same amount would see £25,140 going into their pension at a cost to them of £9,554.
“This would save the employee £15,084 in income tax (paid at 60 per cent) plus 2 per cent in NICs (£502).”
As things stand, employers benefit from this arrangement, as they save 13.8 per cent in employer NICs on the sum paid into their employee’s pension.
But there have been reports that Reeves may add employer NICs to pension contributions at a lower rate. While this would make salary sacrifice less beneficial for employers, the saving scheme “would still be attractive, but not as attractive as it is today”, McCann said.
Labour’s manifesto committed not to increase taxes on working people and said it would not raise national insurance, the basic, higher, or additional rates of income tax, or VAT.
The Treasury said: “We do not comment on speculation around tax changes outside of fiscal events.”