Many people are aware of the impact that inflation can have on their finances. However, there is another phenomenon known as Fiscal Drag that can be just as damaging, if not more so.
Fiscal Drag is a situation where the government fails to increase tax thresholds in line with inflation. This means that as the cost of living rises, more and more people are pushed into higher tax brackets. This is still the case even if their real income has not increased.
To illustrate this, let’s consider the tax-free personal allowance in the UK. If the government had increased this threshold in line with inflation over the past decade, it would now be £13,840. Similarly, the higher rate tax threshold would now be £55,340.
However, because the government has failed to increase tax allowances with inflation, many more people are now paying higher rates of tax than they would have done otherwise. This has a significant impact on their disposable income and can erode their wealth over time.
Fortunately, there are some simple financial planning actions you can take to limit the impact of Fiscal Drag and preserve your wealth. Here are a few suggestions:
- Make use of tax-efficient savings accounts and investments. By taking advantage of tax-free allowances and reliefs, you can reduce your tax liability and keep more of your money.
- Consider deferring income or bonuses. If you have some control over when you receive income, it may be worth delaying it until the following tax year to avoid being pushed into a higher tax bracket.
- Make use of pension contributions. Paying into a pension can reduce your taxable income, and the government offers tax relief on pension contributions up to certain limits.
- Seek professional financial advice. A financial advisor can help you navigate the complex world of tax and make informed decisions about your finances.
In conclusion, Fiscal Drag is a stealth tax that can have a significant impact on your finances over time. By taking simple steps to reduce your tax liability and preserve your wealth, you can limit the effect of this silent killer.
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