Fiscal Drag: What It Is and How to Reduce Its Impact in 2026
With UK income tax thresholds now frozen until at least the 2030/31 tax year, many individuals are likely to see their tax bills rise, even though tax rates themselves haven’t changed. This effect, known as fiscal drag, is expected to impact millions of taxpayers as wages increase with inflation.
In this article, we explain what fiscal drag is, why it matters, and what you can do to help minimise its effect on your finances.
What Is Fiscal Drag?
Fiscal drag happens when tax thresholds stay the same, but your income increases. This could be due to a pay rise or changes to your working hours or responsibilities.
As your earnings go up, you may:
- Start paying income tax when you didn’t before
- Be pushed into a higher tax band, despite no real increase in your spending power
This is why fiscal drag is often referred to as a “stealth tax” — your tax bill increases without any change to the actual rates.
A Simple Example
The personal allowance, which is the amount you can earn before paying income tax, has been fixed at £12,570 since the 2021/22 tax year. Adjusted for inflation, that figure would now be over £14,000.
Because the allowance hasn’t increased, more of your real terms income becomes taxable, even though your money doesn’t go as far as it once did.
Why Have Tax Thresholds Been Frozen?
Income tax thresholds were first frozen in April 2022, and the freeze has been extended several times. Under current policy, the freeze will remain in place until April 2031.
This means the bands will have stayed the same for almost a decade. During that time, many people will pay significantly more tax than they would have if the thresholds had risen in line with inflation.
How Much Could Fiscal Drag Cost?
The cost of fiscal drag will depend on your income level.
- Lower earners may start paying income tax for the first time
- Middle and higher earners are more likely to cross into a higher tax band
Some estimates suggest that the average taxpayer could end up paying over £1,000 more in tax by 2031 than they would have done under inflation-adjusted thresholds.
How to Reduce the Impact of Fiscal Drag
While you can’t avoid fiscal drag entirely, there are several effective steps you can take to reduce your taxable income and improve your overall tax efficiency.
- Review Your Expected Income
Understanding your projected income for the current tax year is a good starting point. Even a modest increase could affect your tax band or reduce your personal allowance.
By planning ahead, you can take action before the end of the tax year to help manage your liability.
- Maximise Your ISA Allowance
If you have cash invested which generates taxable income in the form of interest, you should consider investing in an Individual Savings Account (“ISA”). ISAs are a valuable way to protect savings and investments from tax.
- You can contribute up to £20,000 per tax year
- Income and gains within an ISA are free from income tax and capital gains tax
With upcoming changes to cash ISA rules for under-65s from April 2027, early planning can make a real difference.
- Increase Pension Contributions
Contributing to your pension is one of the most effective ways to reduce your taxable income.
- You receive tax relief on contributions
- Higher and additional-rate taxpayers can claim extra relief
- You may also be able to carry forward unused allowances from the previous three tax years to make higher contributions in the current year
While this reduces your take-home pay now, it increases your long-term retirement savings and lowers your current tax bill. You should always consider speaking to a financial adviser before making substantial pension contributions to ensure it is the right move for you to make both in the short and long term.
- Explore Salary Sacrifice Options
Salary sacrifice schemes allow you to exchange part of your salary for certain non-cash benefits, which can reduce your taxable income.
Common examples include:
- Pension contributions
- Childcare schemes
- Cycle-to-work programmes
These can also reduce your National Insurance contributions in some cases. It’s worth checking with your employer to see what’s available.
- Consider the Timing of Your Income
If your income varies from year to year, it may be worth considering when certain types of income are received. For example, if you’re approaching retirement and expect to be in a lower tax band in future, deferring income where possible could reduce your tax liability.
This might apply to:
- Interest on savings
- Dividends or other investment income
With the right planning, you can avoid unnecessary exposure to higher tax rates.
How IN Accountancy Can Help
With fiscal drag now a long-term consideration, effective tax planning is more important than ever. At IN Accountancy, we help individuals and business owners to:
- Understand their tax position
- Identify tax-saving opportunities
- Plan ahead with confidence
If you’d like tailored advice on managing your income, pension planning, or salary sacrifice arrangements, we’re here to help.
Get in touch with the IN Accountancy team today to take control of your tax planning.
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