Deep Dive #1: How to protect your money from the rising tax tide
Feb 17, 2025
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Carl Emmerson, Deputy Director of the Institute for Fiscal Studies, and Tom Selby, Director of Public Policy at AJ Bell, delve into the UK’s escalating tax burden, projected to hit 38.2% of GDP. They explore practical strategies for individuals to safeguard their finances from rising taxes, highlighting the merits of ISAs and the value of pension schemes. The duo also addresses the potential risks of over-investing in cash ISAs and offers insights into tax-efficient options like VCTs, ensuring listeners are equipped to navigate the intricacies of personal finance.
The UK faces record high taxation projections, largely due to frozen thresholds and increased dividend and capital gains taxes.
Tax-efficient investment accounts like ISAs and pensions provide crucial avenues for mitigating tax impacts while fostering wealth growth.
The 60% tax trap penalizes individuals slightly above £100,000 income, underscoring the necessity of strategic pension contributions for tax relief.
Deep dives
Recent Tax Increases in the UK
The UK is experiencing an unprecedented rise in taxation, with projections indicating a record tax burden of 38.2% of GDP by the end of the current parliament. This rise is largely attributed to increases in personal and capital taxes, contrasting with historical figures, where the tax burden was around 33.1% before the pandemic. Significant changes include hikes in dividend tax rates and capital gains tax, impacting individual investors and small shareholders. The recent drops in tax-free allowances for dividends and capital gains have compounded this issue, leading to nearly double the number of people paying dividend tax compared to previous years.
Understanding Personal Tax Thresholds
Frozen personal tax thresholds have been a key factor in the increasing tax burden due to fiscal drag, whereby inflation causes taxpayers to be pushed into higher tax brackets without any formal increase in tax rates. These thresholds have been frozen since 2021 and are set to remain this way until 2028 for income tax and longer for inheritance tax. This situation can result in individuals paying more tax as their wages increase, fundamentally altering their financial positions and planning. The fiscal drag mechanism is viewed as a strategic approach by the government to increase tax revenues without raising the official tax rates.
Tax-efficient Investing Strategies
Tax-efficient investment accounts like ISAs and pensions offer significant benefits in the current tax climate. ISAs allow for tax-free growth on investments, and choosing the right type—be it cash or stocks and shares—depends on individual goals and time frames. Pensions provide upfront tax relief on contributions, and understanding the nuances between different types of accounts, like lifetime ISAs versus traditional pensions, is crucial for effective financial planning. The combination of utilizing the right tax shelters and maximizing allowances can help investors mitigate tax impacts while growing their wealth.
Pension Tax Relief Concerns
Pension tax relief remains a contentious topic as there are ongoing discussions around the potential for the government to alter the system. Currently, pension contributions benefit from a tax relief system that incentivizes long-term saving, yet the government faces pressure to limit its spending on tax relief for pensions. There are fears that such changes could destabilize personal finance plans, particularly for younger individuals saving for retirement. Maintaining stability in the pension tax relief system is seen as essential to encourage saving and avoid over-reliance on state support in the future.
The 60% Tax Trap Explained
The 60% tax trap occurs when an individual's income exceeds £100,000, leading to the gradual withdrawal of their tax-free personal allowance at a steep effective tax rate of 60%. This peculiar situation effectively penalizes individuals with incomes just above the threshold, as they lose £1 of their personal allowance for every £2 they earn over that limit. The implications are significant, not only affecting earnings but also additional government benefits and allowances. Engaging in pension contributions can be a strategic way to mitigate the effects of this trap by lowering taxable income and preserving personal allowances.
Welcome to the first episode of the AJ Bell Money & Markets Deep Dive podcast. This is a new series which will take a long look at some of the key issues in markets and personal finances. First up we’ll be diving into a subject which will affect almost everyone – taxes. Personal taxes are on the rise and we’ll be looking at some of the main ways you can save tax on your savings and investments.
The tax burden is on course to reach a historic high of 38.2% of GDP by 2029. Laith Khalaf speaks to Carl Emmerson, Deputy Director of the Institute for Fiscal Studies about how we got here, and whether more tax rises are on the way. [11:05]
ISAs have been a hugely successful savings and investment account since their launch in 1999. Laith Khalaf and Charlene Young discuss the merits of ISAs and whether people in the UK are holding too much cash. [30:08]
Tom Selby, Director of Public Policy at AJ Bell joins the pod to discuss another important tax shelter: pensions. We ask him whether a pension is better than an ISA, and if the government might look to take away some of the generous tax relief currently attached to pensions. [40:02]
There are other ways to save tax too. Laith and Charlene discuss family finances, VCTs and the 60% tax trap. [59:08]
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