With the Government focused on closing gaps in the public finances, Income Tax thresholds are unlikely to change, even as wages and the State Pension rise.
Tax thresholds were frozen until March 2028 under the previous Government, and it remains unclear if Labour will alter this.
As a result, more people could find themselves paying Income Tax for the first time or being pulled into higher tax brackets. This is known as fiscal drag.
What is fiscal drag, and how does it affect you?
Fiscal drag reduces the benefit of wage increases, as more of your income becomes taxable.
Employees, employers and directors alike may not feel better off despite a pay rise.
It is often labelled a ‘stealth tax’ because, although tax rates remain the same, more of your earnings are subject to tax.
How to manage fiscal drag
If you have flexibility with your income structure, consider these strategies to reduce its impact:
Do not forget about your personal savings allowance, which allows you to avoid paying tax on savings interest based on your tax band:
Note that there is no personal savings allowance for those in the additional rate band.
For high earners
If you are a higher or additional rate taxpayer (earning between £50,271 and £125,140, or over £125,140), be cautious of wage increases pushing you into a higher tax bracket.
Your Personal Allowance decreases by £1 for every £2 earned over £100,000, meaning it disappears entirely at £125,140.
Higher rate taxpayers are taxed at 33.75 per cent on dividends, while additional rate taxpayers face 39.35 per cent.
As a high earner, fiscal drag can have a major impact, making it important to plan carefully to avoid overpaying tax.