The upcoming Autumn Budget in the United Kingdom may impose significant tax changes affecting high earners. Chancellor Rachel Reeves is reportedly considering measures that could include restrictions on salary sacrifice arrangements and reductions in cash ISA allowances. These alterations would particularly impact individuals earning over £50,270, who currently face a marginal tax rate increase from 20% to 40%, and those earning above £125,140, where the rate rises from 40% to 45%.
Proposed Changes to Salary Sacrifice Arrangements
One of the key proposals under review is the potential cap on tax-free pension salary sacrifice at £2,000 annually. This measure could generate up to £2 billion annually for the Treasury. Under salary sacrifice, employees agree to forgo a portion of their gross pay in exchange for non-cash benefits such as pension contributions or childcare. By reducing their salary, employees and employers pay less National Insurance (NI).
High earners often utilize salary sacrifice to lower their taxable income, allowing them to remain within lower tax bands. For instance, an individual earning just over £50,270 might reduce their salary through this arrangement to avoid the higher tax rate entirely. Currently, there are no limits on how much can be contributed via salary sacrifice before NI applies.
Shaun Moore, a personal tax expert at Quilter, cautioned that such a cap could deter individuals from saving adequately for retirement. He noted that the UK already faces a significant under-saving issue, and additional costs for employers and employees may create further barriers. Similarly, Craig Rickman, a personal finance expert at Interactive Investor, warned that this change could lead to less generous pension offerings, negatively impacting workers’ future retirement savings.
Should this cap be implemented, one strategy for affected individuals is to increase personal pension contributions. Although pension contributions are subject to NI, they provide income tax relief at the individual’s marginal rate. For higher or additional rate taxpayers, this equates to 40% or 45% relief, enhancing retirement funds.
Potential Increases in Income Tax Bills
Initially, the Chancellor had been expected to raise income tax rates to address a budget shortfall. However, recent reports indicate she may instead adjust the income thresholds for higher and additional tax rates. This could entail lowering the threshold for the 40% income tax rate from £50,270 and the 45% rate from £125,140.
For example, if these thresholds were reduced by £5,000, a person earning £60,000 would face an additional £700 in income tax and NI, while someone earning £150,000 would see an increase of £950. All workers earning above £45,270 would experience greater tax liabilities, while those below this threshold would remain unaffected. As previously mentioned, utilizing pensions tax relief could provide a workaround for those facing increased tax burdens.
Changes to Savings Tax Allowances
In the UK, basic rate taxpayers currently benefit from a £1,000 annual allowance on tax-free savings interest, while higher rate taxpayers have this allowance halved to £500. Additional rate taxpayers pay tax on all savings income. Presently, individuals can invest £20,000 annually in cash or stocks and shares ISAs without incurring any income tax or capital gains tax on earnings.
Reeves is contemplating a reduction in the annual cash ISA allowance, with speculation suggesting it might decrease to between £10,000 and £12,000. If enacted, this change would primarily affect high earners, who already have lower allowances for tax-free savings interest and are subject to higher tax rates on interest earned.
For example, high earners making over £125,000 could face over £3,000 in additional taxes on their savings over five years if the cash ISA allowance is cut to £10,000. For those willing to take on more risk, investing in stocks and shares ISAs could be an alternative, as there are currently no indications that these allowances will be reduced. While stocks may offer higher potential returns, they also come with risks not associated with cash savings.
As the Chancellor prepares for the Autumn Budget, high earners should remain vigilant about potential tax changes that could significantly impact their financial planning. Adapting strategies now could mitigate the effects of these anticipated policy shifts.
