What is “fiscal drag” and how could it affect your wealth in 2024?

As Benjamin Franklin famously put it: “In this world nothing can be said to be certain, except death and taxes.”

In this new year, Franklin’s words may feel more poignant than ever as, although rates themselves won’t be increasing, you may find yourself paying more tax.

Indeed, there have already been some significant changes to tax thresholds, allowances, and exemptions over the past couple of years, and some more to come in the 2024/25 tax year.

This is known as “fiscal drag”, and you may also see it referred to as a “stealth tax”, referencing the fact that the government’s tax receipts rise, despite not increasing rates of tax.

So, read on to find out exactly what this means, why you may pay more tax in 2024, and how careful planning can help you reduce your bill.

Fiscal drag sees more of your money subject to tax

Over time, price inflation sees the cost of living increase. For example, the latest Office for National Statistics data shows that prices rose by 4% in the 12 months to December 2023.

This means that goods and services costing £10,000 in December 2022 would have theoretically cost £10,400 12 months later.

You might receive a salary increase in response to this, helping to retain your income’s spending power. Or, if you’re already retired, you might draw more from your pension, investments, and other savings, so you can continue to enjoy your lifestyle despite rising costs.

In turn, the government ordinarily adjusts key tax thresholds, allowances, and exemptions in line with inflation, too. That way, you still pay the same percentage of tax on your income, investments, and other taxable assets, even though the actual amount of tax you pay has increased.

However, this is not currently happening. Instead, the government has frozen and reduced a host of elements in the UK’s tax regime.

So, as your income or the value of your investments or other assets increases, the amount of tax you pay rises too, even though the rates of tax remain the same.

Some of the main tax changes that have come into place, or will be instated in 2024, include:

You may particularly be affected by these changes if you’re already retired. For example, the Income Tax threshold freeze may affect what you draw from your pension or elsewhere. That’s because you may need to take more to continually afford your lifestyle in later life.

Meanwhile, you might be affected by the CGT Annual Exempt Amount reduction if you look to sell certain investments or valuables to derive your income.

Similarly, you may face more Dividend Tax on any dividends you receive as a result of the Dividend Allowance reduction, either from investments or any business interests you hold.

Finally, while they may not affect you directly, frozen IHT thresholds could see your loved ones face a greater tax bill when you die and they inherit your estate.

Careful planning could help you limit the tax bill you owe

While these changes may increase the government’s tax take, it’s worth noting that you can still potentially reduce your tax bill.

Through careful tax planning, there are methods you can employ to do so. Find out below how you could use these to reduce some of the taxes that could affect you in 2024 and beyond.

Remember: the information in this article is not personalised advice, and the right methods for you to reduce your tax bill will entirely depend on your specific situation. Please get in touch with us to find out how you may be able to make your wealth more tax-efficient in your individual circumstances.

Income Tax

If you’re yet to retire, making pension contributions can allow you to reduce your Income Tax bill. That’s because the tax relief you can receive could offset the additional tax you have to pay.

Meanwhile, if you’re already retired, it’s worth thinking about aspects such as:

  • How you take your pension tax-free lump sum, and when
  • Whether you can tactically draw income around the tax bands so you can pay a lower rate
  • Any other tax-efficient ways you can take your income, such as from a Cash ISA.

These methods could help you carefully manage Income Tax in retirement.

Capital Gains Tax

To help mitigate the reduction to the CGT Annual Exempt Amount, it’s worth thinking about making the most of your ISA allowance (£20,000 in 2023/24 and 2024/25).

Any investment returns generated within the ISA wrapper are entirely free from CGT. So, holding your investments within a tax-efficient ISA could allow you to liquidate investments without facing a CGT charge down the line.

Meanwhile, you can also plan around the Annual Exempt Amount – for example, deliberately tactically liquidating investments each year so your gains don’t exceed the exemption threshold.

You could also consider holding assets in your spouse or partner’s name as well as yours. The Annual Exempt Amount counts for individuals, so this essentially means you can double your exemptions by making the most of both of yours.

Dividend Tax

Just as with CGT, any dividends you receive in an ISA are free from tax. So, it could help reduce your bill to invest through an ISA if this is where you get your dividend income.

Similarly, you may also want to carefully plan around your Dividend Allowance, holding investments or drawing from a company so that your dividends don’t exceed the allowance in each tax year.

Again as above, each individual has a Dividend Allowance. So, you could effectively double your allowance if your spouse or partner also receives dividend income.

Inheritance Tax

There are various methods that can help you mitigate an IHT liability. From gifting assets during your lifetime to using trusts, it’s possible to reduce the amount of tax your loved ones may face on your death.

You may have also read our previous article explaining how a pension can be an effective IHT planning tool.

Bear in mind that IHT can be complex, and the right methods for you to use will entirely depend on your personal circumstances. So, it can be sensible to seek professional advice before you try reducing a potential bill yourself.

Get in touch

If you’d like help managing your wealth to make it as tax-efficient as possible this year, please do get in touch with us at Britannic Place.

Email info@britannicplace.co.uk or call 01905 419890 to find out more.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

The Financial Conduct Authority does not regulate estate planning or tax planning.

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