Many commentators have suggested that she might bite the bullet and put an extra 2p in the pound on income tax across all of the tax bands. Now, we clearly don’t know if this is what she is thinking, but if she were, what would be the effects, and how could people mitigate the impact of such an increase?
Of course, that depends on what else she chooses to do. But hypothetically, let’s suppose the commentators are correct, and a 2p rise in income tax is introduced, and that meanwhile she leaves pensions, ISAs, capital gains tax and all the other aspects of the fiscal picture alone.
The first and most obvious consequence is that anyone with an income above the current personal allowance of £12,570 will be immediately worse off. Someone on the UK’s median full-time wage of £37,430 would find themselves paying just over £40 a month more income tax. Someone earning £100,000 a year would be £145 a month worse off.
One positive would be that the tax relief on pension contributions would also rise by 2%, potentially boosting future income in retirement. Pension contributions are probably the most tax-efficient way of mitigating any increase in income tax.
That assumes that the Chancellor chooses not to meddle further with the pensions system, something which would give a boost to the sector and allow it to plan with an element of certainty.
Hard-pressed charities might be pleased to be able to claim an extra 2% Gift Aid on donations as well, boosting their income at a time when fundraising is increasingly difficult and every penny counts.
But for most, a rise in income tax would focus the mind on making sure that they are maximising their tax efficiency, whether that is taking advantage of any available salary sacrifice schemes to minimise their taxable income, or making sure they take full advantage of tax efficient investments such as ISAs and Lifetime ISAs, and schemes such as the Enterprise Incentive Scheme (EIS) and Venture Capital Trusts (these have attractive tax reliefs, but come with a much higher risk to capital, so taking professional advice before investing in them is vital).
Making full use of the ability to transfer income to a spouse or civil partner who may be a non-taxpayer or on a lower tax band should be part of the thinking as well.
For those who are already retired and drawing a pension, any increase in income tax will have a direct effect (unlike any changes to national insurance, which is not levied on pensions and other unearned income). Carefully managing where income is drawn down from and ensuring that income doesn’t creep into a higher tax bracket will become even more important.
We don’t of course know what Mrs Reeves will include in her Budget at the end of the month. But it’s a reasonable assumption that tax rises will be a big part of it, and it is never too early to start thinking about how to mitigate any increases and protect your income.
