What is fiscal drag and how you can avoid it?
Millions more people will find themselves paying higher income tax due to frozen tax thresholds, but there are ways to prepare.
Around 8.3m people will be paying more tax by 2029, a forecast from the Office for Budget Responsibility shows. This phenomenon is known as fiscal drag.
Fiscal drag occurs when earnings rise but tax bands remain the same.
Tax payers are stealthily carried over a limit that hasn’t changed for years, despite having seen growth in their pay. That’s why it’s also known as a stealth tax.
Thresholds have been frozen since 2021, and they’re not expected to move until 2028. So if you’re currently earning just below the £50,270 higher rate tax band, any pay rise you receive would be subject to 40 per cent tax.
How much more tax will I pay?
Data from interactive investor shows high earners on a £100,000 salary in 2025 will pay an extra £2,445 per tax year until 2028.
Middle earners on a 35,000 salary are set to pay an extra £845, while those on a £20,000 salary are due to pay £282 more per tax year.
“The latest OBR forecast spells further bad news for taxpayers, with higher inflation set to inflate the income tax burden even more,” says Myron Jobson, senior personal finance analyst at interactive investor.
“The freeze on income tax thresholds means more people will be dragged into higher tax brackets, while those on lower incomes will see a greater share of their earnings swallowed by tax.”
How can you avoid fiscal drag?
There are ways you can avoid climbing into a higher tax band, and so help reduce the amount you pay in tax.
Increasing your pension contributions is a good way to decrease your taxable income, allowing you to avoid climbing into a higher tax band. On top of that, it’ll benefit you in retirement.
This might be especially useful for higher earners, especially those close to the 60 per cent tax rate that applies to earnings over £100,000.
“Topping up your pension through salary sacrifice is a double win – it reduces your taxable income, helping you avoid fiscal drag, while also cutting your National Insurance (NI) bill,” says Jobson.
“Workers might be able to top up their pension through salary sacrifice, which helps mitigate fiscal drag by reducing taxable income while also lowering NI contributions,” he adds.
“With salary sacrifice, instead of receiving part of your salary (and being taxed on it), you agree with your employer to divert that portion straight into your pension. Since your gross salary is lower, both income tax and NI contributions are reduced before you even get paid.”
A fixed-fee session with Tax Scouts can provide a personalised run-through of your take-home pay, pension allowances, and projected tax savings—making sure you don’t accidentally breach the £60,000 pension cap or overlook any other angle.
As well as a workplace pension, you can pay into a self-invested personal pension or SIPP. Just remember the annual allowance is £60,000 each tax year, so that’s the amount you’ll receive tax relief on. If you pay over that amount, you’ll have to pay tax on the excess.
It’s definitely also worth thinking about putting money into your savings, but consider a tax effective savings vehicle like an ISA. You get a £20,000 allowance, and any interest or investment growth is tax free.
Access interactive investor’s ISA platform to compare different ISA funds and see how directing an extra £5,000 per year into an ISA affects your overall portfolio. Their flat-fee model is especially attractive if you plan to hold multiple investment funds without worrying about percentage-based charges.