The new middle-class tax revolt

Times

5 days ago

Hundreds of thousands of savers are making big changes to the way that they make and spend money for one simple reason: tax.
Some are cutting the hours they work, while others are turning down promotions, giving their pensions away to family members or even considering leaving the country — all because of frozen tax thresholds and upcoming tax changes.
The phenomenon known as fiscal drag — where more people pay more tax as wages increase because tax thresholds remain frozen — means that 6 million more people will pay income tax this tax year than in 2021-22. Almost 7.1 million workers are now in the higher income tax band, up 2.6 million since 2021-22, and the number of additional-rate payers has almost doubled to 1.2 million.
Collectively, we're set to pay £298.6 billion in income tax in 2025-26 — an extra £89 billion compared with four years ago, the latest government figures show, and this is set to rise further because income tax thresholds will remain frozen until at least 2028. We're also on track to pay £6 billion in tax on our savings and £18.6 billion on dividends.
'Fiscal drag has had a devastating impact on the tax we pay. These figures show just how much damage is being done to our finances by this horrible stealth tax — and there is plenty more to come,' said Sarah Coles from the investment platform Hargreaves Lansdown.
So it's no wonder that some families are shaking up their financial behaviour to avoid bigger tax bills. We spoke to four to find out how.
Income tax thresholds have been frozen since 2021, and even those on relatively modest wages are now being dragged into the higher-rate 40 per cent band that is applied to earnings above £50,270 a year.
For families this comes with an added sting in the tail because they start to lose their child benefit entitlement not far above this threshold. Child benefit is worth £26.05 a week for the first child and £17.25 a week for other children, but once one parent earns above £60,000 a year of adjusted income, you have to repay 1 per cent for every £200 earned over that threshold. Once one parent earns £80,000 you get nothing.
Justin King, 55, a financial planner from Christchurch in Dorset, reduced his working hours to ensure that he was still eligible for child benefit, worth about £2,250 a year for Olivia, 16, and Amy, 14.
'I had the option to work more, but the extra income would have been largely eroded by higher tax and the loss of child benefit. When I weighed it up, it just didn't seem worth missing out on time with my family,' he said.
Because eligibility for child benefit is based on adjusted net income — your earnings after pension contributions and certain tax reliefs have been deducted — there are ways you can avoid this trap. Dean Butler from the life insurer Standard Life said: 'Higher earners could consider increasing their pension contributions to reduce their adjusted net income below £80,000. This way you could get some or all of your child benefit back, while also saving for your future.'
• Why high earners are cutting their pay (clue: it's about 600% tax)
There is evidence that more people are doing exactly this. There has been a steep increase in the number of taxpayers with adjusted earnings that are between £1 and £3,000 below the threshold — almost 1 million, up from 893,000 a year earlier, according to HM Revenue & Customs data.
King has started to increase his working hours again now his children are older and the child benefit threshold has been raised — it was £50,000 until April 2024 and went up to £60,000. He said: 'As a financial planner, I often encourage clients to make life choices based on their values, and at that point, family time mattered more to me than extra income. You need to do your sums and work out whether that extra day's work may be more valuable to you and your family than contributing to the Treasury.'
Salary sacrifice is another way to reduce your earnings. Offered by some workplaces, it means agreeing to reduce your salary by a certain amount in exchange for extra benefits such as pension contributions. It means you also save on national insurance payments because you 'give up' part of your salary to go into your pension.
'It's important to note, however, that salary sacrifice can harm mortgage applications and reduce payments based on salary, such as maternity pay, so it might not be right for everyone,' Butler said.
• How free nursery hours for more children backfired
The £100,000 cliff-edge is the most punitive threshold in the UK tax system, with workers in this band facing a marginal tax rate (the amount you pay on the next £1 earned) of 62 per cent.
For every £2 you earn above £100,000 you lose £1 of your £12,570 personal allowance (the amount you can earn each year before paying tax), with the allowance cut to nothing by the time you earn £125,140.
It gets worse for families: once one parent earns above £100,000 a year in adjusted net income, they are no longer eligible for tax-free childcare (a government-backed savings account for nursery fees worth up to £2,000 a year per child) and they lose entitlement to free childcare hours.
Parents with children aged between nine months and two years can get between 15 and 30 hours of childcare funded by the government during term time (rising to 30 for all children aged nine months and up from September). Parents of three and four-year-olds can get 30 free hours. With an average full-time nursery place for a child under two costing £341 a week in England, this can be a vital lifeline.
Once you earn more than £100,000 in adjusted net income you lose the free hours for younger children entirely, and only get 15 hours for three and four-year-olds.
Emily Farmer, 32, from Hampshire, had always aimed to earn £100,000 in her career in marketing, but since her daughter Olivia was born 11 months ago, she has reduced her working hours because it's simply not worth earning more.
'Reaching £100,000 always felt like a career milestone for me, but after having my daughter and nearing this threshold, I made the strategic decision to move to a four-day week,' Farmer said. 'It's a shame to have to sacrifice career progression to make my family finances work.'
Making extra pension contributions can also help workers at this cliff-edge reduce their take-home pay and avoid punitive marginal tax rates, Butler said. 'This could also help you recover some or all of your personal allowance, depending on how much you put in.'
Savers can put up to £60,000 a year into a pension, including tax relief, or 100 per cent of their earnings, whichever is lower. This can be particularly valuable when employer contributions are factored in. However, it is important to consider whether you may need the money early because it is not usually possible to get at your pension savings before 55 (rising to 57 from April 2028) without incurring a large tax bill.
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From April 2027 pensions are set to be included as part of an estate for inheritance tax (IHT) purposes, and this has upended many peoples' financial plans.
Defined contribution pensions (when your pot is based on what you pay in plus investment growth) are exempt from inheritance tax, but with this set to change, many savers are rushing to give away their wealth to avoid a 40 per cent IHT bill when they die.
The tax is paid on estates worth more than £325,000 (£500,000 if they include a main home left to a direct descendant on estates worth up to £2 million). Couples who are married or in a civil partnership can inherit each other's allowances, meaning up to £1 million can be passed on IHT-free. Just under 5 per cent of estates pay IHT in the UK, but this is expected to rise to 8 per cent after 2027, according to HMRC.
Alistair Dickson is concerned that the changes could leave his children with an unwelcome tax bill and is making plans to pass his wealth on as tax-efficiently as possible, including considering putting his house into trust.
Dickson, 57, who lives in Glasgow, is also spending more, using his annual gifting allowance, and is even exploring the idea of moving to Portugal, which has a favourable tax set-up.
Everyone in the UK can give away up to £3,000 a year and it won't count as part of your estate for IHT purposes. You can also make small gives of up to £250 per person, as long as they also haven't benefited from the £3,000 allowance. It is possible to give away much larger sums IHT-free as long as you live for seven years afterwards, after which the gift will no longer be counted as part of your estate.
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You can also give away unlimited regular amounts out of surplus income, as long as it does not affect your standard of living and you keep records to show a pattern of giving. The money must come from income such as earnings, rent, pensions or an annuity, and not from savings.
Adrian Murphy from the financial advice firm Murphy Wealth said: 'For years it was assumed that pensions would be the last port of call for income in retirement — or might never be touched at all — and most of it would find its way to your children,. But that has now changed. This will only drive more people to give assets away or look at alternative strategies.'
Proposed changes to the Isa system are causing more savers to alter their plans. Adults can save up to £20,000 a year into an Isa, in cash or investments, or a mix of both, but it is thought that the chancellor, Rachel Reeves, may slash the cash Isa limit in her October budget, in a bid to encourage more people to invest.
The uncertainty could be having the opposite effect. Savers poured a record £14 billion into cash Isas in April, according to the Bank of England.
Rob Mack usually invests about £500 a month but has been funnelling any spare money into his cash Isa in case the allowance is cut. Mack, 50, from north London, has saved £5,000 so far this tax year and hopes to use as much of the £20,000 allowance as possible before the budget.
'We've made some adjustments to our family finances, moving savings into cash Isas to keep them accessible and tax-efficient. It's essential to have quick access to funds when unexpected expenses arise, like a car repair or a boiler breakdown,' he said.
Murphy is advising clients to use the changes as a starting point to review their investments: 'Cash saving in most cases should be for emergencies and short-term liabilities or expenditure.'