Budget 2025 - Extension of tax threshold freeze will have an ‘eye watering’ impact on the UK’s earners

Today's Budget confirmed that income tax thresholds will be frozen until the end of the 2030-31 financial year, raising more than £8 billion in tax revenue. The policy is a three-year extension to the existing freeze that began in 2021.* 

The Budget also raises taxes by amounts rising to £26 billion in 2029-30, through this and a host of smaller measures, the report says. The report also estimates the UK's tax burden will rise to a record high of 38% in 2030-31.
 
Jason Hollands, managing director at wealth management firm Evelyn Partners, comments:  

‘This is a massive income tax rise by stealth. The power of this policy to increase the income tax and National Insurance burden over the years is really quite eye-watering. 

‘At the start of the century, only one in ten taxpayers were subject to higher rate tax. However, we are now in a position where a fifth of taxpayers are paying the two highest rates of tax, which makes a mockery of the idea that these quite onerous marginal rates should be reserved for the nation’s “high earners”. The numbers exposed to the highest rates of tax will soar to nearly a quarter by 2030.[1] 

‘While the Chancellor can try to argue otherwise, this is very much an increase in income tax on working people across all income levels, as millions more will be drawn into paying income tax at both the basic rate and the higher bands. But as people won’t see an immediate change in their take-home pay and the tax burden just builds over time it is the very definition of a stealth tax. Higher rate tax, once the preserve of the wealthy, is going to be the default rate of middle-income salaried roles, most of whom don’t feel comfortably off, never-mind affluent.  

‘As for the 45% additional rate, since the threshold was cut by the previous Conservative Government from £150,000 to £125,140 in April 2023, this is now catching a much wider cohort than the UK’s very highest earners, which it was originally intended for.

‘When the additional rate was introduced in 2010/11 there were circa 236,000 people paying it, representing 0.75% of all income taxpayers. This year HMRC estimates 1.23 million people will pay this marginal rate, representing 3.15% of all income taxpayers. In fact, over the last decade, the number of additional taxpayers has seen the biggest growth of any tax band (345%). That number is going to continue to skyrocket from here onwards. 

‘But there are troubling effects further down the pay grade. As the personal allowance begins to be withdrawn at the £100,000 mark, this is a destructive precipice where supposed “higher rate taxpayers” begin paying an effective marginal tax rate of 62 per cent on a slice of their earnings up to £125,140. So, we have created a system where there are big disincentives to advancement and pay progression compared to many other comparable nations. This £100k cliff-edge was created in 2010, and if the threshold had increased with UK CPI inflation it would now sit at around £155k.    

‘Those whose earnings mean that they face the punitive tax steps at £100,000 and £125,140 have until now been able to take some refuge by foregoing a pay rise or bonus, or even asking for a pay cut, and having the money paid by their employer into a workplace pension instead – the system known as salary sacrifice. 

‘The Chancellor might today also clamp down on this system, which would be rubbing salt in the wounds and not only demotivate huge numbers of workers but also punish them for doing the right thing by saving for their own retirement. Meddling with pensions in successive Budgets risks damaging faith in the UK’s private pensions system.’ 
What can be done? 

Hollands says: ‘Pension contributions can still be an effective way for earners to lower their ballooning income tax burden, even if a salary sacrifice cap reduces National Insurance savings. Even those who don’t benefit from salary sacrifice schemes at all find that increasing pension contributions can mitigate the effects of the £100,00 cliff-edge by reducing adjusted income. 

'If you derive income from other sources such as a second property, alongside wages and bonuses, that take you into the 62 per cent tax trap or the additional rate threshold, another option to consider if you are married, is to transfer the assets to your spouse if they are subject to a lower tax band. This is known as an “interspousal transfer” and will not trigger a tax charge providing you are married or in a civil partnership. However, such a move would mean fully legal entitlement is passed to your spouse, so trust is vital.   

'Those moving into the rapidly growing higher and additional rate brackets also start to lose the annual Personal Savings Allowance which entitles basic rate to receive £1,000 in savings interest tax-free. Higher rate taxpayers get just a £500 allowance and additional rate taxpayers get no PSA at all, so it could well be beneficial for cash savings to be held by a lower-earning spouse or civil partner.’ 

*The additional rate threshold was cut from £150,000 to £125,140 in April 2023 

[1] The IFS has estimated that this two-year extension to the freezes would leave the total number of income taxpayers at 42.1 million by 2030 (73% of people aged 16 or over) – 5.1 million higher than if there had been no freezes at all. Meanwhile, the number of people subject to income tax at 40% or above is set to soar by 4.8million, relative to if there had been no freezes at all, to 10.1million (18% of people aged 16 or over).