What to do if you move into a higher income tax bracket

The number of workers paying the higher 40% rate of income tax has almost doubled since the government froze tax thresholds three years ago. 

The latest HMRC figures show an extra two million higher-rate taxpayers in England, Wales and Northern Ireland. The jump from 4.43 million in 2021-22 to 6.31 million in 2024-25 is colossal compared to the increase of 220,000 seen during the previous four years.

So what's behind the surge and, if you find yourself paying more income tax, is there anything you can do to reduce the bill?

How much income tax do we pay?

You pay income tax on the money you earn that exceeds the personal allowance – currently set at £12,570. If you live in England, Wales or Northern Ireland, the rate you pay is divided into three bands:

• 20% basic-rate: £12,570 to £50,270
• 40% higher-rate: £50,271 to £125,140
• 45% additional-rate: more than £125,140.

There are different tax bands and rates in Scotland.

Regardless of where you live in the UK, your personal allowance will be reduced by £1 for every £2 you earn over £100,000. This means that by the time you earn £125,140, you'll have to pay income tax on all of your income.

Surge in higher-rate tax payers

Overall, the number of income tax payers has risen by 13% from 33 million in 2021-22 to an estimated 37.4 million this financial year, HMRC data shows.

All tax brackets have seen a rise in numbers, but the biggest increase was seen in the higher-rate taxpayer group – the number of people paying 40% tax on earnings has swelled by a whopping 42% over the last three years, from 4.43 million to 6.31 million. 

To put that into context, if we look at the previous four years – from 2017-18 to 2021-22 – the number of higher-rate taxpayers increased by only 220,000. That's a tiny 5% rise.

This graph shows how the number of higher-rate taxpayers has changed over the past eight years.

What's behind the increases?

HMRC data shows that, since 2021-22, more than two million new taxpayers are also now paying basic-rate tax for the first time, and more than 500,000 have been pushed into the additional-rate tax bracket. The latter tax bracket has seen numbers more than double.

So what's going on?

Ever since the personal income tax thresholds were frozen by the government three years ago, commentators have been warning about the damaging effect it could have on taxpayers' finances – particularly during a period when we have seen record high inflation and soaring mortgage interest rates. 

That's because when wages rise but tax thresholds stay the same, more and more people end up being pulled into higher tax bands and paying extra to HMRC. This phenomenon, called fiscal drag, is often referred to as a 'stealth tax', and the latest HMRC data suggests it has had a huge impact on people's pockets.

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4 ways to lower your tax bill

If you have found yourself pushed into a higher tax bracket, there are a few things you can do to reduce your bill to HMRC.

1. Invest in tax-free savings

For those with larger savings pots, or additional-rate taxpayers, an Isa is a great way to save paying tax on savings interest or investment income.

You can put up to £20,000 in a cash and/or stocks and shares Isa, and any income generated can grow completely tax-free, protecting your savings now and in the future.

You can also hold up to £50,000 tax-free in premium bonds and – while they don't pay any interest on the money you save – every month you'll be entered into a prize draw with a chance of winning anything from £25 to £1m.

• Find out more: best cash ISA rates 2024

2. Pay more into your pension

One of the most common ways to reduce income tax is by contributing to a workplace or personal pension scheme. A basic-rate taxpayer, for example, will get 20% tax relief on the money they put into the pension pot. So if you pay in £100, it would actually only cost you £80. 

It’s a little more complex if you'are a higher or additional-rate taxpayer. Your provider will claim the basic rate of 20% tax relief for you, but you will have to claim the remainder (20% for higher rate or 25% for additional rate) by filing a self-assessment tax return.

For example, say you earn £60,000 per year, putting you into the higher-rate band. By contributing £10,000 to your pension, you will get 20% (£2,000) relief automatically and you can claim another 20% in your tax return. As a result, the total cost to you will work out at just £6,000.

• Find out more: tax relief on pension contributions explained

3. Use your dividend allowance

If you're self-employed and own a limited company, it can be more tax efficient to pay your income in the form of dividends. Not only do they attract lower rates of income tax than salary, there are also no NI contributions payable on dividends.

For example, the basic rate of income tax on dividends is just 8.75%, with the higher rate at 33.75% and additional rate at 39.35%.

There are a number of disadvantages to this, however. Dividends can only be paid out of profits after corporation tax has been deducted (unlike salary, which is a tax-deductible expense). Plus they don’t count as ‘relevant UK earnings’ for the purposes of tax relief on pension contributions that you make yourself.

• Find out more: dividend tax explained

4. Share your allowances 

If you're in a relationship, organising finances between you can make allowances go even further and save you more on tax. 

For example, if your partner has an unused personal savings allowance, then cash could be held in their name instead. Or, if one of you is a lower-rate taxpayer, it might make sense for them to have the bulk of the non-ISA savings so you pay a lower tax rate on the savings interest.

• Find out more: tax on savings interest and investment income