The Unintended Consequences of the 2025 Budget: Five Tax Traps to Avoid

The problem with a smorgasbord budget is that it can create a lot of unintended consequences. The UK tax code currently runs to over 23,000 pages, making it widely considered the longest and most complex tax code in the world. With plenty of traps already lying in wait for the unwary, the 2025 budget has created some more. Here are five areas where people need to watch out.

🪤The £100,000 Tax Trap: How Frozen Thresholds Are Catching More High Earners

Many high earners will be grimly familiar with the £100,000 tax trap. That’s the point at which you start losing your tax-free allowance and childcare support. A relatively small pay rise can be subject to tax rates of up to 60%, rather than the standard 40% higher rate. Historically, people who were bumping up against the threshold could use salary sacrifice to bring them back below it.

🫴🏽Salary Sacrifice Changes Make It Harder to Avoid the 60% Tax Rate

The Budget has made the problem worse in a number of ways. First, frozen thresholds have brought more people closer to the £100,000 level – the limit hasn’t changed since it was introduced in 2010. According to data from Rathbones, almost 2 million taxpayers will lose some or all of their personal allowance in 2025/26.

Also, the government’s clampdown on salary sacrifice makes it more difficult to bring earnings below the level. From April 2029, only the first £2,000 of salary sacrifice will avoid National Insurance. While it will still be effective to reduce your salary, which helps with the childcare limits, your take-home pay will fall.

Alternative Strategies: Limited Companies and Income Equalisation

In practice, any pay rise or promotion that doesn’t put you well clear of the danger zone (say, £90,000 to £125,000) needs to be weighed carefully. Equally, bonuses need to be planned carefully. It may still be worth diverting it towards your pension.

There are other, more complex, options. You could work through a limited company – though after a shift in the dividend rules and rises to corporation tax under the Conservative government this isn’t as tax efficient as it was. However, it does give you flexibility. Of course, not all companies will allow it, and you’ll need to make sure you don’t fall foul of IR35 rules. Equalising your income with your spouse through asset transfers can also be an option.

Dividend Tax Increases: A Double Blow for Small Business Owners and Freelancers

The 2 percentage point increase in dividend tax was another blow for small business owners, consultants and freelancers. These groups make use of limited liability companies and pay themselves in dividends. They have already absorbed a 6% increase in corporation tax under the last Conservative government. Many are now paying similar levels of tax to employed workers, but without the mandated pension schemes, benefits, employment rights or security.

Mandy Girder, a partner at Blink Rothenberg, says: “Changes affecting investment income, savings returns, property income, and dividends disproportionately impact self - employed creatives, contractors, and founders who rely on diversified income streams. For an industry already contending with cash - flow volatility, these measures risk tightening margins further. Expect a renewed push toward day rate increases, faster payment terms, and more transparent contract structures as freelancers work to offset reduced take home pay.”

Dividend Tax Changes Create a Disincentive to Invest in UK Companies

There is a second consequence to the dividend tax – it creates a disincentive to invest in UK companies. The UK market has some of the strongest dividend paying companies in the world. At 3.2% and 3.5%, the FTSE 100 and FTSE 250 are among the highest yielding indices in the world. In other words, more of your return will come from dividends in UK stocks.

How Higher Dividend Tax Undermines Government Goals for UK Stock Market

Laith Khalaf, head of investment analysis at AJ Bell, says:“Rachel Reeves’ decision to add to the dividend tax burden runs entirely counter to the government’s stated aim of getting investors to buy UK shares. The UK stock market pays a healthy dividend compared to other regions, and so it’s made less attractive when dividend taxes rise.”

He says the dividend tax system is actually tilting the table to encourage investors to buy US and global stocks instead of UK ones. “That’s particularly relevant because investors don’t need any further reasons to put their money in overseas investments.” UK equity funds have been in outflow for almost a decade, seeing £68 billion of net withdrawals since 2016.

VCT Tax Relief Cut Triggers Rush to Invest Before April 2026

The Chancellor knocked the rate of tax relief for VCTs from 30% to 20%. She increased the limits at the same time, allowing for larger companies, with more employees, to be eligible for VAT. This is something the VCT industry has been campaigning for – allowing them to support companies for longer.

Oliver Bedford, fund manager at Canaccord Wealth, says: “We expect these changes to bring into scope many exceptional companies that want to invest into innovation and employment but have previously been unable to access funding from VCTs. The UK is brimming with innovation and continues to produce world-class companies. While there is much more to do to improve wider investment into our innovation economy, these changes are further evidence that we are moving in the right direction.”

The Unintended VCT Boom: 538% Spike in Inflows After Budget Announcement

However, the tax changes are a blow. The unintended consequence is that it appears to be sparking a VCT boom, as investors seek to shelter money before tax relief is cut in April 2026. Wealth Club reported a 538% spike in inflows on the Thursday following the budget, as investors rushed to lock in current income tax relief levels. For VCTs, this may lead to a short-term funding boost - or perhaps that as the Chancellor’s intention all along?

Should You Invest in VCTs Before the Tax Relief Drops from 30% to 20%?

Laura Suter, director of personal finance at AJ Bell, says: “These investments aren’t for everyone, they are most often used by experienced, adventurous investors, especially those with large tax bills who have perhaps used up their pension and ISA allowances. But anyone planning to invest in VCTs could consider doing so before April, to lock in the higher tax relief before the rules change at that tax break gets cut.”

State Pension Increases Risk Bringing Low-Income Pensioners Into Tax

Why Frozen Tax Thresholds Could Penalise Small Pension Savers

Increasingly generous UK pension provision is now colliding with frozen tax bands. After a near-5% uplift in the state pension this year, those who reached state pension age after April 2016 will now up to £12,547.60 in the 2025/26 tax year. That is just below the income tax threshold of £12,570. That means the threshold is likely to be breached next year, potentially bringing pensioners solely in receipt of the state pension into the tax net.

While the government has said that those solely in receipt of the state pension will not be taxed, this is likely to create some perverse incentives. Why save for a relatively small pension when it will bring you into the tax net? This could affect around one-quarter of pensions who don’t currently pay income tax. It’s not an immediate problem, but is a factor to consider for the next tax year.

What Still Works: Pension Tax Relief Remains Unchanged

How to Use Pension Contributions to Reduce Your Tax Bill

Suter says it's worth remembering what still exists. She says: "Pension tax reliefs were untouched. You can still get 40% or 45% tax relief on contributions and they'll still reduce your taxable income… You just need to work out what extra contributions you need to make to reduce your adjusted net income. This will involve a little bit of extra admin but will still be well worth it when you consider the potential tax savings on offer."

It was a complicated budget, with complicated impacts. It will keep financial advisers and employee benefits departments busy as they work out the most tax-efficient ways to structure the wealth and remuneration for their clients and employees.