The other day, my annual tax code notice arrived.
And my personal allowance — which, as with most people, is £12,570 — is now very largely swallowed up by the state pension. (Yes — I’m that old…)
So in the coming tax year, if my total earnings and unsheltered investment income exceed a sum just over £2,000 — and they will — then I’ll be paying income tax on them.
Frozen figures create a bigger tax take
It’s no mystery what’s happening here.
The personal allowance hasn’t changed since the 2021-2022 tax year, and neither has the higher rate threshold — the point at which individuals pay tax at 40%, instead of 20%.
Nor will either of them change until 2028, successive chancellors have said.
So consequently, many more people are being caught in the tax net with each passing year, until allowances and income thresholds — hopefully — rise again.
People who didn’t pay tax at all are now paying tax. People who paid basic rate tax are now paying higher rate tax, because their pay rises have taken their earnings above the higher rate threshold of £50,270.
Economists call it ‘fiscal drag’.
Fiscal drag in action
The other day, the Office for National Statistics published some figures — well, quite a lot of figures, really — in a lengthy and detailed annual publication called Personal Incomes Statistics 2021-2022.
The date is significant: that’s right at the very start of the post-pandemic seven-year freeze in allowances and tax thresholds.
But the data already amply illustrates successive chancellors’ miserly approach raising them in the past.
There were 800,000 thousand more basic rate taxpayers than the year before. 400,000 higher-rate taxpayers. And around 70,000 more additional rate taxpayers.
And over the next few years, experts expect that those numbers are going to increase quite significantly.
Squeeze the old
Most troubling is what’s happening with older taxpayers — those individuals above state pension age.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, sums up the situation well:
“Pensioners continue to make a huge contribution to the nation’s tax bill. They now account for over 20% of all taxpayers and almost 15% of total income. One in ten taxpayers is over the age of 75 — this is up from 7% in 2011/12 in a reflection of our ageing society.”
There were 6.74 million taxpayers of state pension age. 409,000 were self-employed, and 1.2 million received employment income. Sure, some people might want to carry on working after the state pension age — me, for instance — but, like you, I know of plenty of people who have jobs on the side because they actually need the money.
And quite a lot — the majority, in fact — are in receipt of non-state pension income, from either past employment or private pensions.
Taxation in retirement
What are the implications of all this for your retirement investment planning?
For those investing through SIPPs, then your pension income is taxable, full stop. And if your state pension and your SIPP income together exceed the personal allowance, you’ll pay tax.
ISA income? Under present tax rules, ISA income is free of tax. This is very handy when you’re building your retirement ISA pot (as is the fact that ISAs are also free from capital gains tax), but is absolutely crucial in retirement.
Because otherwise, you’ll pay dividend tax — a tax that didn’t used to exist, and in my view represents a double tax-grab on corporate earnings. In fact, says Hargreaves Lansdown, this year dividend tax is expected to rake in £17.4 billion for the chancellor.
For basic rate taxpayers, dividend tax (after the £1,000 allowance) is currently 8.75%. For higher-rate taxpayers, it’s a whopping 33.75%. Ouch.
Run for shelter
The bottom line?
In my view, things are only going to get worse.
This coming tax year, the dividend allowance shrinks to just £500 — a mere one-tenth of the £5,000 it stood at when introduced in the 2016-2017 tax year. Any investment income above £500, then you’re liable for income tax.
Yet large numbers of us continue to hold investments in brokerage and investment accounts — with fund supermarkets, for instance — that aren’t tax-sheltered.
Granted, it’s difficult, as you can — under present ISA rules — only shelter £20,000 a year. Limits also apply to SIPP contributions, at least in terms of the allowed tax rebates.
We’re almost at the end of the current tax year. From April 6th, we’re in a new tax year. Over the next month or so, you could shelter £40,000, if you have it sitting in unsheltered accounts. As many of us do.
Do it today. Your retired self will thank you for it.
