| £37,700 @ 20% | £7,540 |
| £79,730 @ 40% | £31,892 |
£39,432 |
Investments & Taxation
Income tax personal allowance planning
Last Updated: 6 Apr 24 3 min read
Overview
Personal allowance planning involves reducing adjusted net income given the £100,000 income limit for personal allowance purposes.
Key Points
- 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 2024/25.
Personal allowance tax planning essentially involves individuals reducing their adjusted net income given the £100,000 income limit for personal allowance 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Taxpayers with income above this limit are potentially subject to a marginal rate of 60% as the personal allowance is withdrawn.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:
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. NICs are 8% for employees earning between the Primary Threshold of £12,570 and Upper Earnings Limit (£50,270) and 2% on all earnings about the Upper Earnings Limit.
| £ | |
| Income | 120,000 |
| Personal pension contribution | (16,000) |
| Income Tax | (31,432) |
| NI | (4,411) |
| Net | 68,157 |
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 | 99,310 |
| Personal pension contribution | Nil |
| Income Tax | (27,156) |
| NI | (3,997) |
| Net | 68,157 |
Stephen's reduction in salary from £120,000 to £99,310 means an employer pension contribution of £20,690 could be made. If the employer also contributed the 13.80% employer NIC saving then an additional £2,855 could be paid giving a potential employer contribution of £23,545.
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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