Understanding the Impact of Threshold Freezes in the UK Budget 2025
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- 2 days ago
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The UK Budget 2025 has introduced several measures that will affect taxpayers and businesses alike. One of the most talked-about changes is the decision to freeze various tax thresholds. This move means that the income levels at which different tax rates and allowances apply will remain the same, despite inflation and wage growth. Understanding how these threshold freezes work and their impact on individuals and the economy is essential for planning finances and anticipating future tax liabilities.
What Are Threshold Freezes?
Thresholds in the tax system determine when different tax rates or allowances apply. For example, the personal allowance is the amount of income you can earn before paying income tax. Similarly, the higher rate threshold marks the point where income is taxed at a higher percentage.
A threshold freeze means these amounts stay fixed for a set period instead of increasing with inflation or average earnings. This approach effectively raises the tax burden over time because as wages rise, more income falls into higher tax bands or becomes taxable when it previously was not.
Which Thresholds Are Frozen in the 2025 Budget?
The 2025 Budget has frozen several key thresholds, including:
Personal Allowance: The amount of income exempt from income tax remains at £12,570.
Higher Rate Threshold: The point at which income is taxed at 40% stays at £50,270.
Inheritance Tax Threshold: The nil-rate band remains at £325,000.
Capital Gains Tax Annual Exempt Amount: The tax-free gain limit is frozen at £6,000.
These freezes are planned to last for multiple years, meaning taxpayers will face increasing tax bills if their incomes rise.
How Threshold Freezes Affect Taxpayers
Increased Tax Burden for Many
When thresholds do not rise with inflation or wage growth, more people pay higher taxes. For example, someone earning £52,000 in 2025 will pay the higher 40% income tax rate on £1,730 of their income because the higher rate threshold remains at £50,270. If the threshold had increased with inflation, less income would be taxed at the higher rate.
Impact on Middle-Income Earners
Middle-income earners often feel the effect most. Their wages may increase slightly each year, but frozen thresholds push them into higher tax brackets or reduce their tax-free allowances. This phenomenon is sometimes called "fiscal drag," where inflation pushes taxpayers into higher tax bands without any real increase in purchasing power.
Effects on Savings and Investments
Freezing the Capital Gains Tax exemption means investors pay tax on smaller gains than they might have expected. This can discourage investment or reduce returns, especially for those relying on asset growth for retirement planning.
Implications for Businesses and Employers
Businesses also face indirect effects from threshold freezes. Employees may demand higher wages to offset increased tax burdens, raising payroll costs. Additionally, companies that provide benefits or bonuses might see these taxed more heavily as thresholds remain static.
Employers need to review compensation packages carefully and consider how tax changes affect employee take-home pay and motivation.
Why Has the Government Chosen to Freeze Thresholds?
The government’s rationale for freezing thresholds is primarily to increase tax revenues without raising tax rates. This approach helps manage public finances and fund services without introducing new taxes or increasing existing rates.
However, critics argue that threshold freezes are a stealth tax increase that disproportionately affects middle earners and those on fixed incomes.
Examples of Threshold Freeze Effects
Example 1: Income Tax
In 2024, Jane earns £48,000 and pays 20% income tax on income above £12,570.
In 2025, Jane’s salary rises to £51,000.
Because the higher rate threshold is frozen at £50,270, Jane pays 40% tax on £730 of her income.
If the threshold had increased with inflation, Jane might have avoided paying the higher rate.
Example 2: Inheritance Tax
A family home valued at £350,000 passes to heirs.
The inheritance tax threshold remains at £325,000.
£25,000 of the estate is subject to inheritance tax.
If the threshold had risen, less or no inheritance tax might apply.
How to Prepare for Threshold Freezes
Review Your Income and Tax Position
Check how your income compares to frozen thresholds. If you are close to a higher tax band, consider options to reduce taxable income, such as pension contributions or charitable donations.
Plan Investments Carefully
Be aware of the frozen Capital Gains Tax exemption and plan asset sales to minimize tax liability. Spreading gains over multiple years or using tax-efficient accounts can help.
Discuss Compensation with Employers
If you are an employee, talk to your employer about salary adjustments or benefits to offset increased tax burdens. Employers may offer tax-efficient benefits like childcare vouchers or cycle-to-work schemes.
Seek Professional Advice
Tax rules can be complex, especially with changing thresholds. Consulting a tax advisor can help you understand your situation and plan accordingly.
Broader Economic Effects of Threshold Freezes
Threshold freezes can slow consumer spending because taxpayers have less disposable income. This effect may dampen economic growth, especially if wage increases do not keep pace with inflation.
On the other hand, increased tax revenues can fund public services, infrastructure, and debt reduction, which may benefit the economy in the long term.
What to Watch for in Future Budgets
Keep an eye on announcements about when and if thresholds will be adjusted. Governments sometimes reverse freezes or introduce new allowances to ease tax burdens.
Also, monitor inflation and wage trends, as these will influence how much threshold freezes affect you.
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