Certain Britons have been warned they face a particularly nasty tax trap as higher earners brace themselves for the Budget on October 28. Those who cross the six-figure threshold can suddenly find themselves losing valuable tax breaks and Government support while effectively paying a marginal tax rate of 60%. Wealthy older people face additional fears over possible raids on their savings, investments, property and estates.
Two groups under the spotlight
Financial experts have dubbed the two groups 'Henrys' – High Earners, Not Rich Yet – and 'Heros' – High Earners, Rich and Older. Henrys may be earning around £100,000 but are often younger and have not yet built up significant assets. Heros have been earning at this level for longer and have accumulated savings, investments and property.
Both groups face a heavy tax burden as well as the notorious £100,000 cliff edge. Sarah Coles, head of personal finance at AJ Bell, said: “The nation is braced for the Budget, but higher earners will be particularly wary. Whether you’re a ‘Henry’ with a higher income and few assets, or a ‘Hero’ with both high earnings and plenty of savings and investments, you’re likely to be worried you could be in the frame to pay more tax when we emerge from the other side of Andy Burnham and John Healey’s inaugural Budget.”
The £100,000 cliff edge
The tax trap begins when someone's income creeps above £100,000. Between £100,000 and £125,140, the personal allowance is gradually withdrawn. This means that for every £2 earned above £100,000, £1 of the personal allowance is lost. The result is an effective tax rate of 60% on this slice of income. Once earnings reach £125,140, the personal allowance has disappeared altogether and the taxpayer moves into the 45% additional-rate tax band.
The sting can be even worse for families with children. Crossing the £100,000 threshold can mean losing tax-free childcare worth up to £2,000 per child a year. It can also mean losing some or all of the funded childcare hours. For someone with two children, the benefits lost could be worth more than £25,000 a year, according to AJ Bell.
Wealth tax fears
Heros face a separate set of worries because they have more assets to lose. There have already been proposals for wealth taxes, including a suggested 2% levy on assets above £100million and calls from a group of millionaires for a 2% tax on sums above £10million. A new wealth tax of this kind is not broadly expected in the Budget because of the complexity of administering it and concerns it could encourage avoidance. But the prospect may still alarm wealthy savers and investors.
There are also fears over how the cost of social care could be funded in future – particularly among those who have spent decades building up substantial estates. Investors have already faced a squeeze, with dividend tax and capital gains tax allowances cut and rates increased in recent years. AJ Bell warns that further pain could be on the way.
More dragged into 45% tax
Higher earners could also face further pressure if tax thresholds are changed. The additional-rate threshold was cut from £150,000 to £125,140 in April 2023 and has remained frozen. AJ Bell says 1.3 million people are expected to pay the 45% additional rate this year – more than double the number in 2021/22.
There have also been calls for the top rate of income tax to rise. Another perennial Budget concern is pension tax relief, particularly for higher earners. AJ Bell has called for a Pensions Tax Lock to rule out changes to pension tax relief and tax-free cash before the Budget, arguing that speculation could prompt people into making rash decisions over their long-term finances.
What can people do?
Higher earners can take steps now to make their finances more tax-efficient. One option is to consider moving taxable savings into a Cash ISA. Pension contributions can also be particularly valuable because tax relief is available at the individual's highest marginal rate. For someone who has breached the £100,000 threshold, pension contributions can potentially reduce adjusted net income and help restore eligibility for some childcare support.
Investors should also consider making full use of the £20,000 annual Stocks and Shares ISA allowance. Existing investments outside an ISA can potentially be moved into the tax-efficient wrapper using a Bed and ISA process. Married couples and civil partners can also make use of both partners' ISA allowances, while parents can put up to £9,000 a year into a Junior ISA for each child under 18.
For experienced investors willing to accept substantial risk, Venture Capital Trusts and Enterprise Investment Schemes can offer tax advantages, although these are high-risk investments. Ms Coles said: “When you’re on a higher income, especially if you have built assets, the stakes are higher. At the same time, some of your options become more complicated. It’s one reason why Henrys and Heros might consider whether it’s a good idea to speak to a financial adviser ahead of any potential Budget changes.”
