Reeves' silent squeeze on the middle class

The quiet squeeze on middle-class workers has pushed the number of higher-rate taxpayers past five million for the first time. Official figures show that an additional 680,000 people have been pulled into the 40 percent tax bracket compared to the previous tax year.

This milestone comes amid concerns that Rachel Reeves may extend the ongoing freeze on personal allowances and tax thresholds in her upcoming mini-Budget, despite pledging not to introduce further tax increases.

Many have called out this move as yet another example of ‘stealth tax’ - or to give it the formal name, ‘fiscal drag’.

The future of the freeze

The latest data for 2022/23 is just the beginning, with projections suggesting the total number of higher-rate taxpayers could climb to nine million by 2028, potentially reaching ten million by the end of the decade.
Income tax thresholds were originally frozen in 2021 by then-Chancellor Rishi Sunak to help repair public finances following the Covid-19 pandemic.

While the policy was initially set to last until 2026, Jeremy Hunt later extended it to 2028.
Normally, tax thresholds rise in line with inflation. However, when they remain fixed, rising salaries push more people into higher tax brackets—the phenomenon known as fiscal drag.

To make matters worse, those pulled into the 40% tax bracket are at risk of falling into the 60% tax trap.

What is the ‘60% tax trap’?

Since 2010, those earning more than £100,000 a year have had their personal allowance tapered away until it is completely eliminated for earnings over £125,124.

The ‘60% tax trap’ refers to the income band of £100,000 to £125,000 between which earners in England and Wales will effectively experience a 60% tax rate on their income. This is because for every £2 you earn over £100,000 each year, you lose £1 worth of your £12,570 tax-free personal allowance. Your tax rate only returns to the normal amount of 40% after the entirety of your personal allowance for that year has been deducted, which is at just over £125,000.

For example, an £100,000 earner who receives a bonus of £1000 will only receive £400 of his bonus. This works out as follows:
He immediately loses £400 to the standard 40% tax, leaving him £600.

As he loses £1 for every £2 earned over £100,000, his £1000 bonus translates to £500 deducted from his original tax-free personal allowance. This deduction of £500 is then retroactively taxed at his current standard rate of 40%, meaning he pays another £200.

After paying the original tax of £400 and then the subsequent tax of £200, he is left with only £400 of his original £1000 bonus, meaning he has effectively experienced a 60% tax rate.

How can I avoid falling into the tax trap?

Fortunately, the solution is fairly straightforward. By choosing to make pension contributions on any excess income you earn over £100,000, you can effectively prevent your taxable income from going above the £100,000 threshold and into the 60% tax trap.

Thanks to the Government ‘bonus’ that is paid into your pension whenever you make a contribution, by opting to pay excess income into your pension, you not only save your excess from being taxed 60%, but you also gain a little more than you put in.

HMRC does not consider the excess that you put into your pension as part of your taxable income and therefore will adjust your income back down to £100,000, saving you from the 60% tax trap while also paying you a little extra for putting some pension savings away. It’s a win-win for any serious saver.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. 

The Financial Conduct Authority (FCA) does not regulate cash flow planning or tax advice.