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Technical View

Holding on to the personal allowance

Currently once taxable income reaches £122,000*, because the personal allowance is reduced by £1 for every £2 of income over £100,000, your personal allowance will disappear (*£123,000 from 6th April 2017 when the personal allowance goes up to £11,500). 

Income between £100,000 and £122,000 is taxed at 40% and so the effective tax rate for those affected is 60% (40% + 20% for the loss of the personal allowance). 

So, can you help mitigate or avoid losing this valuable personal allowance?  The simple answer is yes and you can consider 1 of two options:

1. Make pension contributions


This can be done either as a personal contribution, or by an employer as part of a salary sacrifice agreement.  Pensions are not caught by the recent changes for salary sacrifice arrangements and so setting up a new pension salary sacrifice arrangement or increasing an existing arrangement is entirely possible.

Case study

Dev is 43, employed and has taxable earnings for the 2016/17 tax year of £140,000.  He is a member of his Defined Contribution (DC) occupational pension scheme and makes personal contributions of £15,000 gross (on top of employer contributions of £15,000) per year.  A total of £30,000.  As a result of having adjusted net income of £110,000,(£140,000 - £30,000) Dev’s personal allowance is reduced by £5,000 (£10,000/2) to £6,000.

To regain his full personal allowance, Dev can either make a personal contribution of £8,000 net (£10,000 gross), or his employer could make a contribution of £10,000 (gross) via salary sacrifice.

Making a personal contribution extends his basic rate band, and the employer contribution via salary sacrifice lowers his taxable income.  It also gives an NI saving to both Dev and his employer. 

That’s all very well, but the following month Dev gets a payrise that puts his salary up to £150,000 so now he may also be subject to the tapered annual allowance.  For those with Threshold Income over £110,000 and Adjusted Income over £150,000 (see https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm057100#Income) , their annual allowance for the tax year is reduced along the same principles as the reduction for the personal allowance (£1 reduction for every £2 by which Adjusted Income exceeds £150,000, up to a maximum reduction of £30,000). 

If Dev’s Adjusted Income is over £150,000, his annual allowance will be reduced and this will impact on the amount that can be contributed by Dev or his employer to his pension fund.  He will need to look closely at past contributions and ensure that he is effectively making use of carry forward of unused annual allowances from previous years. To do this, Dev must first use his full (albeit tapered) current years allowance.  Then, starting with the oldest year first (which was 2013/14 with the last remaining annual allowance of £50,000) he can carry forward unused allowances from up to the previous three tax years.

The way an individual’s Adjusted Income is worked out is essentially taking the Threshold Income and adding pension contributions back on.  Dev’s adjusted net income (for personal allowance purposes) also his Threshold Income, is £120,000 (£150,000 less £30,000 pension contributions) so if he were to make a contribution to regain his personal allowance on net adjusted income of £120,000, he or his employer would make a further gross contribution of £20,000.  This would put his Adjusted Income up to £170,000 (£120,000 + £50,000) and reduce his annual allowance by £10,000 ((£170,000 - £150,000) / 2 = £10,000).  This is not a huge problem for Dev because he still has unused annual allowances from previous years that he can use to recoup that lost £10,000.  Also he has regained his full personal allowance.

Of course every individual’s circumstances are different and there will come a point where the sacrificing of annual allowance for pension savings will no longer outweigh the benefit of regaining the personal allowance.  It is a delicate balancing act.

2. Charitable donations


Alternatively an individual can hope to recoup some or all of their lost personal allowance is by charitable donations e.g. via gift aid.  When an individual donates to charity via gift aid, they are only paying the net amount to the charity, yet they receive the gross amount back as an increase to their basic rate band in much the same way as for pension contributions.  Again, these have an effective tax saving of 60%.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.