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Income Tax Personal Allowance Planning

3 min read 6 Apr 22

By The Technical Team

In this article

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Personal allowance planning involves reducing adjusted net income given the £100,000 income limit for personal allowance purposes.

  • Taxpayers with adjusted net income above £100,000 are potentially subject to a marginal rate of 60%
  • Pension contributions can be highly tax effective since they are deductible in calculating adjusted net income

What is the personal allowance?

The personal allowance is the level above which income tax is levied on an individual's annual income. As explained in article Income tax personal allowance: the facts, the amount of an individual's 'adjusted net income' can impact on personal allowance entitlement.

Note that under Scottish and Welsh income tax rules, the personal allowance and thresholds on taxes on savings and dividends remain a UK ‘reserved’ matter.

Planning

Comments and examples relate to 2022/23.

Personal allowance tax planning essentially involves individuals reducing their adjusted net income given the £100,000 income limit for personal allowances purposes

Taxpayers with income above this limit are potentially subject to a marginal rate of 60% as the personal allowance is withdrawn. In particular therefore a pension contribution can be highly tax effective since it is deductible in calculating adjusted net income.


Example showing the benefits of a pension contribution which reduces a client’s adjusted net income to £100,000

Stephen who lives in Manchester has net income of £120,000. If he pays a pension contribution of £20,000 gross then his adjusted net income for personal allowance purposes will be £100,000.

Without a pension contribution Stephen's personal allowance is £2,570 and taxable income after personal allowance is therefore £117,430. This is taxed as follows:

£37,700 @ 20% =

£7,540

£79,730 @ 40% =

£31,892
 

£39,432

Payment of the pension contribution will restore Stephen's personal allowance to the full £12,570. His taxable income after personal allowances of £107,430 is taxed as follows:

£37,700 @ 20% =

£7,540  

£20,000 @ 20% =

£4,000

£49,730 @ 40% =

£19,892
 

£31,432

The tax relief on his pension contribution is therefore £4,000 + (£39,432 - £31,432) = £12,000 which equates to an effective rate of 60%.

Stephen's net income after tax, pension contribution and National Insurance is as set out below. National Insurance is calculated using the ‘Effective Annual Threshold’ of £11,908 which refers to the Primary Threshold level if the weekly level was applied for a full year. This is based on the Primary Threshold being £9,880 from 6 April 2022 until 5 July 2022, and then £12,570 from 6 July 2022 until 5 April 2023.

 

    £

Income

120,000

Personal pension

contribution

(16,000)

Income Tax

(31,432)

NI

(7,349)

Net

65,219


If Stephen entered into a salary sacrifice arrangement with his employer then a higher pension contribution could be made by his employer due to the NI saving as follows. For further information on salary sacrifice see the article Salary Sacrifice.

 

    £

Income

98,855

Personal pension

contribution

Nil

Income Tax

(26,974)

NI

(6,662)

Net

65,219

Stephen's reduction in salary from £120,000 to £98,855 means an employer pension contribution of £21,145 could be made. If the employer also contributed the 15.05% employer NIC saving then an additional £3,183 could be paid giving a potential employer contribution of £24,328.

Other measures

Outside of pension contributions, individuals can take steps to preserve entitlement to personal allowances by:

  • Charitable giving

  • Transferring investments to a spouse / civil partner

  • Control the timing of income where appropriate (e.g. bonus / dividend from family company)

  • Invest in tax exempt investments (ISAs, certain National savings products)

  • Invest in non-income producing investments (investment bonds)

  • Careful timing when encashing investment bonds - withdrawals within 5% limits do not fall within adjusted net income but chargeable event gains do

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