Budget 2021: What does Rishi Sunak’s raid on income tax, inheritance tax and pensions mean to you?

The old adage about tax is that the Treasury must pluck the maximum of feathers from the goose with the minimum of hissing.

One way guaranteed to cause a hissing fit among the British public is to announce you are putting up the income tax rate.

So, politically savvy chancellors such as Rishi Sunak like to deploy more subtle means.

Welcome to “fiscal drag”.

This is where, rather than increase the rate of tax, you simply freeze at this year’s levels the earnings thresholds at which existing tax rates apply.

As wages rise with inflation, more people fall into the higher bands of tax, and so the tax take rises with relatively little pain - in the short term, at least.

What has the Chancellor done to my income tax today then?

He’s announced that he’s keeping the personal allowances for income tax at their current levels right up until the end of the 2025-26 tax year.

So, that’s:

The first £12,500 you earn is tax free

The next £12,501 - £50,000 is taxed at 20%

The next £50,001 - £150,000 is taxed at 40%

Everything over £150,000 is taxed at 45%

According to the Office for National Statistics, pay is currently increasing at a rate of 4.7% a year, so if you’re currently earning just below any of those thresholds, the chances are you’ll be going through them to the higher rate of tax pretty soon.

That’s sneaky! Why is he doing it?

Because he wants to raise more money, and fast to try and get a grip of the public finances. To raise the kinds of taxes he needs, he has to tap millions of people for it. Keeping the tax thresholds at their current levels will hit the vast majority of the working population.

The very richest - those earning more than £150,000, are less impacted that those on middling pay. Those on low incomes suddenly finding themselves getting taxed will feel it the most.

Interestingly, the move today is a sharp reversal of the trend in income tax since the Coalition government, which has seen the thresholds held down over the years. Echoes again of today’s reversal of George Osborne’s super-low corporation tax.

How much is Rishi going to raise from the income tax wheeze?

A lot, and, as inflation rises, it increases every year. So, while next year it’s only £1.55 billion, by the 2025-6 tax year he’s hoping to raise some £8.18 billion. That’s getting close to putting 2p on the pound of income tax.

That is a (fiscal) drag indeed. Any other devious meddling with my income today?

Yes, I’m afraid so. He’s doing a similar job on your inheritance tax liabilities and pensions allowances, freezing the tax free thresholds until 2025-6 again.

How does that work?

On inheritance tax, you pay no tax on the estate you’re inheriting up to £325,000. Again, as with income tax, traditionally that threshold goes up in relation to inflation, but the Chancellor is keeping it on hold for the next five years.

Most people’s estates are largely made up of their property, and given that house prices are currently rising at an annual 6.9%, you can see that will soon start bringing in a lot more lolly for the taxman.

How much is he raising from the IHT threshold freeze, then?

Not as much as income tax, because IHT affects a far smaller number of people, but Rishi’s still talking about raising £445 million a year by 2025-26.

What’s he doing to my pension?

Currently you’re allowed a pension pot of up to £1,073,100 before you start getting taxed on it. Above that level, when you draw down your pension, you get taxed at 55% if you take it as a lump sum and 25% if you take it in regular payments.

Again, it’s not as big a pot of cash for the Treasury as the fiscal drag on income tax but it’s still an extra £300 million a year by 2025-6.

How can I avoid paying these extra taxes?

PWC tax partner Alex Henderson says the thing about fiscal drag is that people rarely bother trying to avoid it through aggressive tax planning techniques. Largely because you don’t really realise it’s happening until it’s too late.

Tax experts talk of the boiling frog. Stick a frog in boiling water and it will jump straight out to save its life. Put it in cold water and slowly turn up the heat and it won’t perceive the danger until it’s too late.

I wouldn’t bother trying to avoid your income tax or you’ll probably end up falling foul of the HMRC. With inheritance tax, you can always have the estate passed to the spouse or, as ever, if you arrange it so it’s passed on to the children as long as seven years elapse before the estate owner dies, they get it tax free.

As for the pensions situation, unfortunately the Treasury is effectively encouraging you to stop saving for your retirement as your pot approaches the £1 million level. Mixed messages from a society that’s been trying to get us to look after ourselves in our old age.