Economic pull: Understanding fiscal drag and strategies to evade its effects

Hear ye, hear ye! With frozen tax thresholds, millions more folks are about to fork over more cash to Her Majesty's Revenue and Customs. Here's the lowdown on how to steer clear of the fiscal drag that lies ahead.

By 2029, approximately 8.3 million of us will be shelling out more in taxes, according to the Office for Budget Responsibility's forecast. This nasty little economic phenomenon is none other than fiscal drag, folks! Fiscal drag occurs when income rises, yet tax brackets remain stagnant, leading to an unseen tax hike. It's like a sneaky tax increase in broad daylight, with nary a whisper of warning.

Since 2021, thresholds haven't budged an inch, and they're projected to stay put until 2028. So if you're earning just shy of the £50,270 higher rate tax band, any raise in pay will be hit with a 40% tax rate.

So just how much more tax will I be dishing out?

High earners scooping up £100,000 in 2025 can expect to plunk down an extra £2,445 per tax year until 2028, according to data from interactive investor. Middle earners eking out £35,000 will part with an additional £845, while those making £20,000 will fork over an extra £282 per tax year.

"The latest OBR forecast is a big ol' storm cloud for taxpayers, with higher inflation poised to amplify the income tax burden even further,'' says Myron Jobson, senior personal finance analyst at interactive investor.

"The freeze on income tax thresholds means more people will be sucked into higher tax brackets, while those on lower incomes will see a greater share of their hard-earned dough vanish like magic before their eyes."

To dodge the fiscal drag, check out these winning moves:

Ramp up your pension contributions to decrease your taxable income and cushion your retirement fund. This strategy could prove especially lucrative for higher wage earner's steaming towards the 60% tax hike on earnings above £100,000.

"Boosting your pension through salary sacrifice is a double whammy – it scales back your taxable income, helping you dodge fiscal drag, while also lowering your National Insurance contributions,'' says Jobson.

"Thanks to salary sacrifice, you and your employer agree to redirect a slice of your wages straight into your pension. Since your take-home pay shrinks, both income tax and National Insurance contributions get whittled down before you even receive your paycheck."

A one-on-one session with Tax Scouts can offer a personalized peek at your post-tax take-home pay, pension allowances, and projected tax savings. Just make sure you don't accidentally overstep the £60,000 pension cap or overlook other financial angles.

Along with a traditional workplace pension, consider stashing cash in a self-invested personal pension (SIPP). However, remember the annual allowance is £60,000 each tax year, so that's the amount you'll receive tax relief on. If you funnel in more, prepare to shell out tax on the excess.

Last but certainly not least, think about sinking funds into your savings, but consider a tax-efficient savings vehicle like an Individual Savings Account (ISA). You get a £20,000 allowance, and any growth or interest is tax-free!

Jump on to interactive investor's ISA platform to weigh different ISA funds and observe how shoveling an extra £5,000 per year into an ISA impacts your overall portfolio. Their flat-fee model is a lovely option if you're planning to hold multiple investment funds without stressing over percentage-based charges.

Armed with this knowledge, you're well on your way to navigating the tricky waters of fiscal drag. Keep your peepers peeled and your wits about you in these challenging times!

With millions more people expected to pay more in taxes due to frozen tax thresholds, considering personal-finance strategies such as ramping up pension contributions might help reduce your taxable income, hence steering clear of the fiscal drag.
To better understand how much more tax you might need to pay, consider scheduling a one-on-one session with Tax Scouts for a personalized analysis of your post-tax take-home pay, pension allowances, and projected tax savings.
As a strategy to boost your savings, consider investing in a self-invested personal pension (SIPP) alongside a traditional workplace pension. However, be aware that the annual allowance for SIPP is £60,000 each tax year, so any excess contributions will be subject to tax. Alternatively, consider a tax-efficient savings vehicle like an Individual Savings Account (ISA), which offers a £20,000 allowance and tax-free growth or interest.