Two million extra people will pay higher rate tax over next four years – here’s what they need to know

The number of higher rate taxpayers in the UK will rocket 65% in the next four years from 4.1million to 6.8million, according to the Office for Budget Responsibility.

The threshold for 40% tax has been frozen at £50,270 until April 2026. Without that freeze, it was expected the number of higher rate taxpayers would have risen steadily from 4.1m in 2021/22 to 4.8m by 2025/26. Previous OBR estimates suggested that freezing the threshold until 2026 would create an extra one million higher rate taxpayers on top of that.

As a result of rising inflation, the OBR now estimates an additional two million people will be dragged into the higher rate of tax by the freeze.

Number of extra higher rate taxpayers in UK created by freezing threshold

With so many new higher rate taxpayers in the UK, thousands of people will be unaware of the traps to watch out for.

Sean McCann, Chartered Financial Planner at financial advisers NFU Mutual, has outlined five issues for new 40% taxpayers.

1.    Claim back extra tax relief on your pension contributions

Sean said: “Once you become a higher rate tax-payer you become entitled to extra tax relief on your pension contributions. It’s estimated that around £750m in higher rate tax relief goes unclaimed each year.

“If your employer deducts your pension contributions before you pay tax, you’ll get the extra tax relief automatically. Otherwise you’ll need to claim via a tax return.”

2.    The amount of tax-free interest you can enjoy reduces by 50%

Sean said: “Basic rate taxpayers can receive up to £1,000 of tax-free interest on their bank and building society accounts.

“Once you become a higher rate taxpayer this reduces to £500 and disappears completely once you become a 45% taxpayer.”

3.    Watch out for the Child benefit tax charge

Sean said: “Once your income reaches £50,000 – which is just below the higher rate threshold - if you or your partner are claiming Child benefit you’ll need to think about the Child benefit tax charge

“If you’re the higher earner, for every £100 of Income you have over £50,000 you’ll need to repay 1% of your child benefit.

“You become liable for the charge if you live with someone who claims child benefit, even if they’re not your children.

“You’ll need to complete a tax return and make HMRC aware. If you wait for them to contact you, you could be faced with back payments and penalties.

“One way to mitigate the child benefit tax charge is to make additional contributions to your pension.”

4.    Taxes on dividends increases

Sean said: “All UK taxpayers can enjoy £2,000 of tax-free dividend income each tax year.

“Anything over £2,000 is taxable.  If it falls in the basic rate you pay 8.75% - once you become a 40% taxpayer the rate you pay shoots up to 33.75%.

“Any part of your dividend income that falls in the additional rate band - income over £150,000 - is taxed at 39.35%.”

5.    You can claim back tax on your charitable donations via gift aid

Sean said: “If you donate £100 to charity via gift aid, the charity can claim an additional £25 from HMRC.

“Once you begin paying 40% income tax you can claim up to an additional £25 for yourself via your tax return. This is an additional 20% tax relief on the total value of the gift including the gift aid amount.”

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