April 2026 Client Newsletter

Tax Distortions and Disincentives

The OBR and OECD agree…

“…a higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected. While the level of the tax take in the UK is not unusually high compared to other advanced economies, there is some evidence that UK marginal rates of tax may be above the OECD average and this may be more relevant for impacts on incentives to work, save, and invest.”

OBR Economic and Fiscal Outlook March 2026:

“There is scope to improve the efficiency and fairness of the UK tax system. Parts of the tax system are complex, leading to large compliance costs... Furthermore, distortions such as kinks in the income tax schedule weaken work incentives…”

OECD April 2026:

When the Office for Budget Responsibility (OBR) and the Organisation for Economic Cooperation and Development (OECD) both highlight distortions in the UK tax system, it suggests there are serious problems. The OBR is sufficiently concerned that it has promised to “conduct further analysis of UK marginal tax rates relative to other countries” in its 2026 Fiscal Risks and Sustainability Report. For its part the OECD recommends that the UK “conduct an in-depth tax review to make the tax system more efficient and growth-friendly by reducing distortions, closing loopholes, and ending reliefs and exemptions that do not serve economic or social objectives”.

The Income Tax Rollercoaster

One target of the OBR and OECD is the way in which successive UK Chancellors have tweaked the income tax rules to raise more revenue without touching the political third rail of headline tax rates. The Chancellors’ focus has been on meeting short-term fiscal targets with seemingly little or no thought given to the broader consequences for the economy. To make matters worse, many of the income tax allowances and thresholds have been frozen for years, with some, such as the personal allowance and higher rate threshold, not due a thaw until at least 6 April 2031. That means, each year, a new group of taxpayers encounters the tax distortions as their income rises.

The graph below is a simple example of how the UK income tax system (outside Scotland), creates a roller coaster of tax rates for an employee with two children eligible for child benefit:

Based on an employee with two children aged seven eligible for child benefit:

• On earnings between £12,570 (the personal allowance) and £50,270 (the higher rate threshold), an employee faces an effective tax rate of 28% – 20% basic rate income tax and 8% Class 1 National Insurance contributions (NICs – which are income tax in all but name).

• Between £50,270 and £60,000 (the high income child benefit taper threshold), their marginal tax rate is 42% – 40% higher rate tax and 2% Class 1 NICs.

• From £60,000 to £80,000 (the top of the high income child benefit taper threshold), their marginal tax rate jumps to 53.7% – 40% basic rate tax, 2% Class 1 NICs and an 11.7% high income child benefit charge.

• Between £80,000 and £100,000 (the personal allowance taper threshold), the marginal rate drops back to 42%.

• Between £100,000 to £125,140 (the top of the personal allowance taper threshold), the marginal rate leaps 62% – 40% higher rate tax, plus another 20% income tax as the personal allowance is tapered away and 2% Class 1 NICs.

• Beyond £125,140 (the additional rate threshold) the marginal rate drops again to 47% – 45% additional rate tax and 2% Class 1 NICs.

There are two other complexities worth noting, which we have avoided to keep the graph simple:

• In Scotland there are six income tax rates, creating further distortions and a marginal rate in the £100,000-£125,140 band of 69.5% - 45% advanced rate tax, plus another 22.5% income tax as the personal allowance is tapered away and 2% Class 1 NICs.

• At £100,000 there is a cliff edge where tax-free childcare and, outside Scotland, some or all free childcare, is lost. The marginal tax rate in those circumstances heads towards infinity – an extra £1 of income can mean the loss of thousands of pounds in benefits.

Will The Government Do Anything?

The concerns of the OBR and OECD echo criticisms which have been around for many years from think tanks such as the Institute for Fiscal Studies. Unfortunately, Chancellors have little incentive to make the system more rational:

• The data to understand the impact of the distortions does not exist. Last November, a Freedom of Information Request revealed the Treasury has no estimate for the income tax revenue lost because parents act to keep income below the £100,000 threshold.

• To remove the kinks would cost billions which the Treasury does not have. Even if it did, there would probably be other more deserving candidates, such as defence.

• Any attempt to make the system smoother without reducing revenue would inevitably create winners and losers. The former are generally silent, whereas the latter tend to be uncomfortably noisy.

• The anomalies are poorly understood because of the complex way in which they operate, which suits politicians. Stealth taxes have never been high on the priority list for reform and Rachel Reeves has shown little interest in redesigning the tax system.

As with the frozen allowances, doing nothing benefits the Treasury. According to the latest HMRC projections, about £1 in every £8 of income tax comes from those taxpayers with income in the £100,000-£150,000 band, almost as much as paid by their higher earning counterparts in the £200,000-£500,000 band.

What Can You Do?

The starting point is to work out what your income is for 2026/27, so that you know where you fit on the roller coaster graph above. That is not quite as easy as it sounds because the definition of income is not straightforward – advice may be necessary. If your income is in the taper band for high income child benefit or personal allowance, think about whether you can bring the income down. There are a variety of options, including:

• Reduce your working hours. This may sound counter-intuitive, but for some people, forsaking £20,000 of taxable income to gain childcare benefits can make financial sense.

• Pension contributions. Paying into a pension reduces your ‘income’ when calculating how taper applies and entitlement to childcare. The popularity of this option was partly behind the Chancellor’s 2025 Budget measure to limit the use of salary sacrifice for pension contributions, albeit not until 2029/30. 

• Restructure your investments. The way in which investments are held can determine what – if any – income you receive from them for tax purposes. ISAs are the obvious example because their income is not subject to UK tax, but there are other options. For example, you could transfer investments to your spouse/civil partner – provided you do not create a threshold problem for them. (Any such transfer must be outright and unconditional.)

Action

Early in the tax year is the best time to start planning – before too much income accrues. Even if the tax thresholds have not been a problem for you in the past, those constant freezes mean they might be in 2026/27.

Student Loans – A Small Respite For Some

The topic of student loans is one that flares up every so often and the past few months have been one of those occasions. Ironically, a major reason for the recent inflammation was a move by the Chancellor in the last Budget to increase the income threshold at which certain graduates in England and Wales start to make payments towards their loans. Another cause may have been that some of the youngest MPs are now feeling the pain of student loan repayments based on their Parliamentary salary…

Good News…And Bad News

For those with Plan 2 Loans – students in England who started courses between 2012 and 2022, and Welsh students since 2012 – from April 2026, Rachel Reeves raised the income threshold at which loan payments begin from £28,470 to £29,385. The increase came with a sting in its tail: there will be no further rise until 2030/31. A freeze is nothing new in this area, as the threshold remained the same for four years from April 2021 under the previous government.

The freeze works in much the same way as the personal allowance freeze, dragging more graduates into having to make payments and, for those already caught, increasing their payments each year their income rises. As a further twist, freezing the payment threshold means that many graduates see the basis for the rate of interest on their loans rise.

Payments And Interest – Not What They Seem

Student loans, especially the Plan 2 variant, are unlike any other loans. There is a good case for saying they are more akin to a tax than a loan, although no government would willingly own up to such an idea. For Plan 2 loans:

• The repayment term is a maximum of 30 years, after which any outstanding debt is written off.

• Payments are at 9% of gross income above the income threshold, operating in a similar way to an extra 9% income tax. That means an English higher rate taxpaying employee receives 49p out of every extra £1 they earn, with the other 51p being income tax (40p), NICs (2p) and student loan payment (9p).

• After graduation, ‘interest’ is charged on any outstanding loan at a rate based on the Retail Prices Index (RPI), even though it is no longer an accredited official statistic. The interest rate is RPI where income is at or below the payment threshold, rising gradually to RPI+3% for income of over £52,885. As the average debt is around £50,000 on graduation, payments for many younger graduates will not cover the accumulating interest, meaning their outstanding debt increases. 

An Interest Rate Cap – Also Not Quite What It Seems

The growing rumblings about student debt (and a likely jump in inflation for March 2026) prompted the government to announce, in early April, that it would be introducing a 6% cap on interest for Plan 2 loans “to provide certainty for borrowers in an uncertain world”. This sounded like good news, but, for many graduates, it makes no difference.

For a start, it is only for one year (starting in September, when the student loan year begins). It only benefits those who would otherwise be paying above 6%, which based on a March 2026 RPI of 3.3% means graduates with income of at least £50,535. Anyone with a lower income will be subject to an interest rate below the cap and thus see no benefit from the cap. At best, a high earning graduate is spared about £150 in interest, assuming a £50,000 debt.

The Government Bind

In March 2025, the value of all outstanding student loans was £267bn. To put that in context, the student debt pile is equal to about a quarter of the total tax revenue for 2025/26. Next time you hear a politician talking about writing off student debt, those are numbers to remember. They also explain why the government can do little about easing student debt – the cost runs into billions instantly. The unspoken corollary is that the student loan system is a useful source of revenue – Rachel Reeve’s three-year freeze on the payment threshold netted the Treasury a one-off £5.6bn in last year’s Budget.

Graduate Lessons

If you or your children have outstanding student debt, you may be tempted to pay some or all of it, financial resources permitting. In practice that may be a foolish idea, even if the ‘interest’ being charged is 6% (or more in future years). The most recent government forecast is that only about a third of Plan 2 students in England who started their courses in 2022/23 will fully repay their loans. That means paying more than the mandatory 9% could be a waste of money as it could only reduce the amount that is written off after 30 years. The picture is different for today’s graduate high earners, the group that is projected to repay in full. However, even then, caution is necessary as the high earnings may not last.

If you have children or grandchildren who hope to go to university, there is a case for building up funds for them now. However, those funds should not be earmarked solely to cope with student costs. It is better to think of them as providing your child/grandchild with financial flexibility after graduation, perhaps to buy their first home or start a business.

The New State Pension Age

The State Pension Age (SPA) is on the move again. On 6 April 2026, it rose one month to 66 years and one month for anyone born between 6 April 1960 and 5 May 1960. That process will continue until 6 March 2028, when anyone born after 5 March 1961 will have a SPA of at least 67.

Not The End Of The Story

Under existing legislation dating back to 2007, a further phased SPA increase to 68 is due to start in 2044. This has already been subject to a couple of reviews, both of which proposed bringing the date forward, but neither of which received government blessing. A third review began last July and is expected to report later this year.

Whatever that review decides, the next SPA increase will not start before April 2037 because of a government promise to provide a minimum of ten years’ notice of any change.

Money, Mortality And Morbidity

State Pension spending accounts for 5% of UK GDP, up from 2% in the mid-20th century. Small changes can therefore yield a significant savings to the Exchequer. For example, the OBR reckons that by the early 2070s, three SPA increases (to age 69) will cut annual pension expenditure by about 1% of GDP – about £30bn in today’s terms – compared to holding the SPA at 66.

While those calculations give the government a clear incentive to keep pushing up the SPA, there are obstacles in the way of a march towards an SPA of 70:

• Unsurprisingly, SPA increases are not popular with the electorate. The arguments about the increase in women’s SPAs, which started in 2010, continue to this day. There is a suspicion that the two reviews on the SPA increase to 68 were both put on hold because of impending elections.

• Although life expectancy continues to rise, the pace of increase has been much slower than projected in the early 2010s. In theory, that should imply a less rapid rise in SPA.

• Rising life expectancy has not been matched by a similar increase in healthy life expectancy. The latest data from the Office for National Statistics shows healthy life expectancy falling to its lowest level since 2011-2013.

Making Your Own Retirement Date Choice

The current State Pension is £241.30 a week (£12,548 a year). If you choose to retire before your SPA, that is an inflation-proofed £1,000+ a month (before tax) of income that you will not receive until you reach SPA.

Covering such a shortfall needs to be planned for. There are a range of ways this can be done, with increasing pension contributions being only one of the possibilities. Which option or combination of options is best will depend on your personal circumstances.

Time For An Inheritance Tax Rethink

Estate planning is something many of us put off for understandable reasons. However, procrastination has become an expensive option following the changes to inheritance tax (IHT) introduced by the Chancellor in her last two Budgets.

Source: OBR EFO March 2026

The Changes

The Chancellor has introduced two major reforms which will see the amount of IHT raised increase by nearly 70% between 2025/26 and 2030/31:

• Business and agricultural reliefs. New IHT reliefs for businesses and farms came into effect on 6 April after considerable controversy. The most significant was the creation of a £2.5 million capped allowance on the amount of business and/or agricultural property which can qualify for 100% IHT relief. The allowance is transferable between spouses and civil partners in the same way as the IHT nil rate band. Once the allowance is exceeded, relief is reduced to 50%.

  
  

  There has also been a reduction in IHT business relief for holdings of eligible AIM shares, which is now 50% in all instances.

  
  

• Pension death benefits. From 6 April 2027, most pension death benefits (other than death-in-service) will be treated as part of the deceased’s estate and potentially subject to IHT. As income tax also generally applies to pension death benefits on death at age 75 or older, this can mean that the overall tax rate on an unused pension fund is as much as 67% (68.8% in Scotland).

There was one other IHT Budget change which arguably counts as continued no change. The nil rate band (£325,000 since 2009) and residence nil rate band (£175,000 since 2020) are now frozen until 5 April 2031.

Rethink

The reforms are already prompting some of those affected to rethink their estate planning strategies. Building up a large pension pot to pass over on death is no longer the cunning plan it once was. Similarly, waiting to transfer a business or farm until the will is read may now make less sense than a lifetime gift.

If the new regime makes an IHT bill inevitable, this could be the time to revisit an old solution to IHT – whole of life assurance placed in trust for your beneficiaries to help fund the tax liability whenever it arrives.

Action

IHT is a rapidly increasing source of tax revenue that could see HMRC as one of the larger – if the not the single largest – beneficiary of your estate.

If you have not reviewed your estate planning in 2026, now is the time to do so

The 2028 Mansion Tax

A feature of recent Budgets is the announcement of tax changes that are deferred for several years. The changes to IHT on business and pensions are a good example. So too is another directed at wealth: the high value council tax surcharge (HVCTS), aka mansion tax. 

Full Details Still Awaited…

The Autumn 2025 Budget announced that the new tax would come into effect from April 2028, for properties valued at least £2 million in 2026 (with no specific date given). Despite the reference to council tax in the name, HVCTS will go into the government’s coffers, with council involvement limited to collecting the new tax alongside council tax and passing it on. A consultation document was promised ‘early in 2026’, but by mid-April none had arrived. However, we do know the rates:

Price band based on 2026 valuation	Surcharge (CPI linked) from April 2028
£2.0m - £2.5m	£2,500
£2.5m - £3.5m	£3,500
£3.5m - £5.0m	£5,000
£5.0m +	£7,500

OBR Insight

The lack of consultation did not stop the OBR from publishing its thoughts on the impact of the new tax, which included:

• By 2028, the capitalized value of the surcharge would be fully reflected in property prices. This would imply a reduction of about £35,000 per £1,000 of surcharge, based on the OBR’s assumed inflation rate of 2% and a discount rate of 5%.

• Prices will bunch just under the various HVCTS thresholds, just as happened when the stamp duty rate was based on property values. There is already anecdotal evidence that this is happening.

• The band structure will encourage valuation appeals, which the OBR expects will apply to 20% of properties initially deemed liable. Four in ten of those appeals is forecast to succeed.

• The revenue raised by the HVCTS will be partially offset by lower stamp duty, capital gains tax and IHT because of reduced property values.

Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding current law and HM Revenue & Customs practice as at 22 April 2026. No action must be taken or refrained from based on its contents alone. Accordingly, no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.