In the March 2024 Budget, Jeremy Hunt announced a second cut to National Insurance (NI), which could reduce your tax liability. Yet, as the chancellor didn’t unfreeze other allowances, many workers will see their overall tax bill rise in real terms due to fiscal drag.
Fiscal drag refers to a phenomenon where the government increases revenue by freezing thresholds rather than increasing them in line with inflation. So, even though tax rates don’t increase – and in some cases fall – your tax liability may still rise. During periods of high inflation, which the UK has experienced over the last few years, the effect of fiscal drag can be magnified.
So, while you might welcome the news of National Insurance cuts, it may not have as much impact on your finances as you first believe.
29 million workers will pay less National Insurance in 2024/25
Rishi Sunak’s government first made cuts to NI in the 2023 Autumn Statement and then made a further announcement in the March 2024 Budget.
According to the government, reducing employee and self-employed NI is “the best way to target working people, supporting growth and making the tax system fairer”.
It’s estimated that 29 million workers will benefit from the reduced NI rate. The second cut is collectively worth more than £10 billion a year for workers across the UK, according to the Budget document.
The rate of NI employees will pay in 2024/25 fell from 10% to 8% on 6 April 2024, following a cut from 12% to 10% that came into force on 6 January 2024. It’s calculated that the two cuts combined will save the average worker earning £35,400 more than £900 a year.
Self-employed workers may also benefit from a reduction to the main rate of Class 4 NI contributions, which has fallen from 9% to 6%. In addition, Class 2 NI contributions were abolished. The combination of these measures is expected to save the average self-employed person earning £28,000 around £650 a year.
So, on the face of it, the NI cuts suggest that workers will be better off in 2024/25.
Frozen Income Tax thresholds could increase your tax burden
The amount you can earn before being liable for Income Tax, known as the “Personal Allowance”, and thresholds for paying the higher and additional rate have been frozen until April 2028. Previously, they have usually increased each tax year in line with inflation.
As average wages rise, more people will start paying Income Tax or move into a higher tax bracket. So, while you might see your NI bill fall, overall your tax liability could rise in real terms.
Indeed, according to the BBC, by 2027, the average earner would only be £140 better off – and only people earning between £32,000 and £55,000 a year would be better off despite the NI cuts.
As a result of fiscal drag, a report in FTAdviser suggests that 3.8 million people will be brought into a higher tax bracket over the coming years and face a shock tax bill as a result.
It’s not just your Income Tax liability you might need to be mindful of. Moving into a higher tax bracket could affect other allowances.
For example, if you become a higher-rate taxpayer, your Personal Savings Allowance (PSA) – the amount you can earn in interest on savings before they could become liable for Income Tax – would halve to just £500 a year. If you moved into the additional rate bracket, your PSA would be £0.
Moving into a higher tax bracket could also affect the rate of Capital Gains Tax you pay, as well as other areas of your financial plan.
There could be ways to potentially reduce your Income Tax bill
If you could be dragged into a higher tax bracket, one way to potentially reduce your tax bill is by increasing your pension contributions.
As tax is calculated after pension contributions are made, increasing how much you’re saving for retirement could be a useful way to avoid being pulled into a higher tax bracket.
Remember, pensions are not usually accessible until you’re 55 (rising to 57 in 2028). So, it may be important to weigh up the pros and cons of increasing your pension contributions with your short- and medium-term finances in mind before you proceed.
There might be other steps you could take to reduce your tax liability too, such as making charitable donations from your income or using a salary sacrifice scheme. Please contact us to talk about your options.
Get in touch to discuss how to make tax efficiency part of your financial plan
Managing your tax liability could help you get more out of your money and turn long-term aspirations into a reality. Please contact us to arrange a meeting to talk about your tax bill and the steps you may be able to take to reduce it.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.