Understanding Personal Income Tax Changes for 2025/26
The recent Autumn Budget 2024 has reaffirmed a series of personal income tax decisions. Impacting UK taxpayers in the coming years. With tax bands and allowances largely frozen until 2028, this “stealth tax” approach is expected to affect a growing number of taxpayers over time. Here’s a closer look at what this means and how you can plan accordingly.
Frozen Tax Allowances and Rates Through 2027/28
In 2023, the previous Chancellor confirmed that the main personal allowance and the 40% higher rate threshold would remain at their 2022/23 levels until at least 2028. This freeze, often referred to as a “stealth tax,” effectively raises the amount of tax collected each year without explicitly increasing rates.
Impact Example:
- A taxpayer with a salary of £50,270 in 2024/25 will pay approximately £7,540 in income tax. Should their income increase by 10% to £55,297 before 2028, the entire increment will be taxed at 40%. Raising their total income tax to £9,551.
For higher earners, the personal allowance is tapered for incomes above £100,000 and is completely phased out at £125,140, triggering a 45% tax rate. In this “tapering band,” an effective marginal rate of 60% applies. Meaning that any income growth could result in a disproportionately higher tax burden for individuals earning near this threshold.
High Income Child Benefit Charge (HICBC) Remains in Place
The High Income Child Benefit Charge (HICBC) still applies to the higher-earning partner in a household if they receive Child Benefit and earn over £60,000. For income between £60,000 and £80,000, HICBC applies a gradual clawback. With 1% of the total benefit being reclaimed for every £200 of additional income until the benefit is fully reclaimed at £80,000.
Initially, it was proposed to calculate this based on the household’s combined income rather than the higher earner’s income alone. However, the Chancellor has opted not to adopt this change, keeping the charge focused on individual earnings.
Scottish and Welsh Rates of Income Tax
In Scotland, income tax on non-savings and non-dividend income may differ from the rest of the UK. Often with higher rates for middle and higher-income taxpayers and slight reliefs for low earners. The Scottish government’s budget announcement, scheduled for December 4, 2024, will clarify these rates for the 2025/26 tax year. Welsh income tax also varies and is determined by the Welsh government.
Planning for the Freeze in Allowances and Rates
With allowances and rates frozen for the foreseeable future. Tax planning becomes crucial to minimize liabilities and retain more of your earnings. Here are some strategies to consider:
- Salary Sacrifice: If your income is close to a higher tax band, salary sacrifice for pension contributions or other pre-tax benefits can help avoid higher rates while building your financial future.
- HICBC Mitigation: For those subject to HICBC, making additional pension contributions or using salary sacrifice can lower taxable income, reducing the benefit clawback.
- High-Income Planning: With the personal allowance phased out above £100,000, adjusting income distribution (e.g., through dividends or family trust structures) could mitigate effective high tax rates.
Welsh Income Tax Update
The Welsh government, like Scotland, has the authority to set income tax rates for Welsh taxpayers. Although Wales has yet to deviate from the main UK tax rates, this could change with the upcoming draft Welsh Budget announcement on December 10, 2024, with finalisation scheduled for February 25, 2025. Any adjustments may directly impact Welsh taxpayers, making it crucial to stay updated on potential changes as they may affect personal budgeting and tax liabilities.
Dividend Income and the Reduced Allowance
For those with dividend income, the tax landscape has tightened with a reduced dividend allowance. For 2025/26, this allowance remains at £500, down significantly from the previous £2,000 in 2022/23. Taxpayers earning dividends over this amount must report these earnings, as HMRC does not automatically track dividend income. The tax rates on dividends exceeding £500 remain steady, with an 8.75% rate for basic rate taxpayers, 33.75% for the upper rate, and 39.35% for the additional rate, applicable across the UK.
Planning Tips: With recent reductions in the dividend allowance and increased tax rates on dividends, tax-free investment options like ISAs and Venture Capital Trusts (VCTs) have become more appealing. Dividends within an ISA or VCT are tax-free, offering a way to shelter dividend income from taxation while growing investment portfolios more efficiently.
Savings Income and Allowance Details
The savings allowance continues for 2025/26, with basic rate taxpayers receiving a £1,000 allowance, higher rate taxpayers £500, and no allowance for additional rate taxpayers. Savings income that surpasses these thresholds may need to be declared for tax purposes. Additionally, the £5,000 savings rate band remains intact, with non-savings income taking priority in the band, followed by any savings income within that unused portion taxed at 0%.
Example: If a taxpayer’s non-savings income falls short of using the £5,000 savings rate band entirely. Their savings income within the remaining band may still benefit from the 0% rate.
Seek Professional Guidance for Tax-Efficient Planning
Navigating the evolving tax landscape can be challenging, but Merranti Accounting is here to help. Whether you’re preparing for HICBC, impacted by allowance freezes, or need guidance on salary sacrifice options. We offer expert tax planning tailored to your situation.
Contact us today for a consultation on strategies that can protect your income and ensure tax efficiency amidst these changes. Let’s plan a proactive approach to keep your finances optimized for the future.
