Tax freezes will be a tax rise over time

Saying that, the tax freezes have been seen as tax increases by stealth.

For income tax purposes, the tax free personal allowance, basic rate tax band and higher rate tax band will increase from April 2021 in line with inflation (£12,570, £37,700 and £50,270 respectively) but will then remain unchanged thereafter until April 2026.

Les Cameron, head of technical at Prudential UK, says: “His higher rate liability isn’t as much as it could have been as the government raised the higher rate threshold keeping some of his money at 20 per cent. Next year as the thresholds are frozen all of the pay rise will be subject to higher rate tax.  

“The freezing of the income tax thresholds will only raise taxes for those who have an increase in salary that moves them across a threshold, that is, a non taxpayer starts to have some income in the basic rate band (at £12,570) or a basic rate taxpayer starts to have some income in the higher rate tax band (at £50,270).” 

The threshold for being subject to a child benefit tax charge (£50,000), a withdrawal of personal allowance (£100,000) and additional rate tax (£150,000) have always been frozen since they were introduced.

Tax freezes become tax rises because over time, wages and asset values tend to rise Rebecca O'Connor, Interactive Investor

Cameron adds: “There is no actual history of inflationary increases to the rates bands and allowances, it has largely been policy decisions. The personal allowance increased substantially from 2010. It was at this point the withdrawal of personal allowance for those with income over £100,000 was introduced.”

Rebecca O’Connor, head of pensions and savings at Interactive Investor, says: “Tax freezes become tax rises because over time, wages and asset values tend to rise.

“Wage inflation is currently around 3 per cent. This means someone who was earning £49,000 would be earning £50,470 in a year. 

“This would push them over the threshold for higher rate tax, where anything you earn over £50,000 is taxed at 40 per cent instead of 20 per cent.” 

So on that £470 above £50,000 that they are earning, they would pay £188 tax instead of £94.

Richard Churchill, a partner at Blick Rothenberg, says: “If someone currently earns £25,000 and receives a £1,000 pay rise, this represents a 4 per cent pay rise and therefore their pay is broadly staying in line with inflation meaning what they can afford to buy remains unchanged. 

“However under the current rules all of the additional £1,000 will be subject to tax at 20 per cent and a further £200 in tax paid meaning their net money will increase by £800. For households this is the critical measure as it is their take home pay which is available to them to spend.”

Adam Dunnet, director at Zefra, says: The headlines suggest that the Chancellor has been generous in protecting people against tax rises, although once you scratch away at the surface, it becomes clear that the freezes – both to rates and allowances across the board – will serve as an effective way of appeasing public opinion while increasing tax revenues.

CGT

The annual exemption amount for Capital Gains Tax will remain unchanged at its current level (£12,300) until April 2026.

Mainstream investors investing in stocks and shares and Oeics will not really be impacted by this as they will manage their disposals to ensure their gains stay within the limit.   

The main impact is likely to be those who cannot phase their disposal, for example business owners and property investors. These people will see an increase in tax as more of their gain will be subject to tax as the tax free amount has not risen.

Richard Taylor, senior wealth planner at Sanlam, says: "Personal investor clients have [breathed] a sigh of relief. The fact there had been a consultation and the rumour mill was that potentially people would get clobbered with a [CGT increase], the fact that has remained unchained, most people see that as a bonus.

"But then conversely you have your business clients who, with the increase in corporation tax, will probably see that and think [it's another thing hitting them, when they have already had it quite difficult]."

Inheritance tax

The Chancellor announced that both the nil rate band and residence nil rate will remain at existing levels until April 2026. 

The nil-rate band (NRB) will continue at £325,000, while the residence nil-rate band will remain at £175,000. 

This means a single person maximising the nil rate bands can pass on up to £500,000 with no inheritance tax liability while a married couple or those in a civil partnership can pass on up to £1m without an inheritance tax liability.

The NRB has remained at £325k for an individual since the 2009/10 tax year.  The residence NRB and the main nil rate band were due to increase by CPI from 2021/22 but this will now not happen. 

The amount of IHT paid and estates paying IHT has been increasing since the nil rate band was frozen and this continued freezing will see that trend continue. 

Cameron says: “How will this raise tax? Quite simply with the amount of estate you can have tax-free frozen, this means people with an existing IHT liability will see that grow as their estate grows. Some people’s estates will not grow and take them over the tax free amount and into the IHT net.”

While the chancellor expects to raise an additional £1bn from these measures, Cameron says that certain actions can be taken to avoid having to pay an IHT charge: 

• Spend the money
• Make outright gifts to individuals or trusts
• Invest in tax wrappers which are outside the IHT “net” e.g. pensions
• Invest in assets which attract relief e.g. Business Relief
• Insure the tax liability

And as has always been the case, one of the best IHT planning tools available is a suitability drafted Will to ensure that full benefit is made of any NRB and RNRB available.

LTA

Finally,  pensions received similar treatment as the capital gains tax with the lifetime allowance of £1,073,100 being frozen again to April 2026.

This is likely to bring a number of people into tax charge territory; even at modest growth levels.

Having the ceiling frozen for a period of five years will certainly catch a number of people out (if the Lifetime Allowance increased in line with inflation it would increase by a further £88,900 over that period). The freeze is estimated to generate around £250m in tax.

It is therefore as important as ever that individuals are aware of exactly where all of their pension arrangements sit today, so as not to walk unwittingly into avoidable tax charges. This is especially the case for active members of defined benefit pensions, including doctors, teachers and civil servants.

While £1m sounds like a lot of money, when someone needs to rely on this to repay the mortgage and then fund potentially 30 or 40 years of retirement, this can lead to a very real risk that the money will run out.

Andy Springford, partner at Mazars, says by freezing the LTA at the same level for a period of five years, this effectively ‘caps’ part of their remuneration package, which in turn will act as a disincentive to continue to accrue benefits within the scheme and can therefore lead to retirement decisions being brought forward.

He adds: “There is certainly a risk that the LTA freeze can lead to doctors retiring early. The NHS Pension remains a generous defined benefit arrangement, and a very important part of doctors’ overall remuneration package.  

“We have already seen a number of doctors ‘opting out’ of the NHS Pension scheme due to the annual and lifetime allowance tax implications, and so the decision to freeze the LTA will not help matters.

"The decision last year to increase the annual allowance thresholds was welcomed by doctors, and so this recent LTA decision will take the shine off of this somewhat.”

Ima Jackson-Obot is deputy features editor of FTAdviser