The Personal Allowance (PA) represents the amount of income that an individual can earn free of income tax. The standard PA for those under 65 years old is £8,105 per annum (2012/2013).
In a move to increase the taxation of higher earners, the Treasury introduced a change to the legislation back in April 2010 that seeks to remove the personal allowance of those people earning over £100,000.
Since April 2010, people with ‘net adjusted annual income’ of over £100,000 will have their personal allowance reduced or even removed. The reduction is at a rate of £1 for every £2 of income over £100,000.
Based on the current standard personal allowance, this means that anyone with income over £116,210 will lose their personal allowance completely. This means that an additional £8,105 of income for such higher earners is now being taxed at 40% or even 50%, whereas before this date it was not taxed at all.
The effective marginal tax rate on earnings between £100,000 and £116,210 is a whopping 60%! For those with earnings over £100K, there are certainly several immediate financial planning opportunities worth considering to avoid some or all of this 60% tax rate tax – the so called ‘Personal Allowance Trap’.
1. Annual gross personal pension contributions for example may be deducted from total annual earned income for the calculation of adjusted income.
2. Certain donations to charity that qualify for gift aid can also reduce total income
3. Certain other investment structures qualify for significant tax rebates which can serve to offset the effect of this increased tax on income. Timing and suitability are key here but securing tax refunds from HMRC that exceed the additional taken is often possible.
4. Moving investments that generate income from taxed to tax free environments can also reduce an individual’s ‘net adjusted annual income’.