The personal allowance – set at £10,600 for 2015/16 – is reduced by £1 for every £2 by which a person’s adjusted net income exceeds £100,000. This means that where a person has adjusted net income of £121,200 or above in 2015/16, they will lose their personal allowance in its entirety.
60% marginal rate
The abatement of the personal allowance creates a ‘spike’ in the marginal tax rate. Where adjusted net income is between £100,000 and £121,200 (2015/16 figures), the combined effect of the 40% tax rate and the reduction in the personal allowance creates a marginal tax rate of 60% where income falls within this band.
Trap :
The loss of the personal allowance means that the marginal rate of tax paid where income is between £100,000 and £121,200 is a massive 60% - this is 15% above the additional rate of tax of 45%.
Avoiding the 60% rate
There are various strategies which can be adopted to reduce income and preserve the personal allowance and in doing so avoid paying tax at a marginal rate of 60%.
Strategy 1 – Make pension contributions
Contributing to a registered pension scheme is a good way to preserve the personal allowance and to enjoy the tax reliefs associated with making pension contributions. Contributions to a registered pension scheme attract tax relief at the individual’s marginal rate of tax to the extent that they do not exceed the annual allowance for the year (£40,000 for 2015/16) plus any unused annual allowance for the previous three years. Further, pension contributions are deducted from income in arriving at adjusted net income.
Example 1: Tax-efficient pension contribution
Bill has adjusted net income of £121,200 before pension contributions. He makes a contribution to a registered pension scheme of £21,200 (gross) for 2015/16 and in doing so reduces his adjusted net income to £100,000.
Making the contribution reinstates his personal allowance in full and saves him tax £12,720, while allowing him to save for his retirement.
Strategy 2 – Transfer income to a spouse or civil partner
In some cases it may be possible to transfer income to a spouse or civil partner or maybe another family member in order to preserve the personal allowance.
Example 2: Gift of shares
Helen has adjusted net income of £125,000, of which £30,000 is investment income from shares which she holds. Her husband has adjusted net income of £40,000.
By transferring the shares to her husband (on a ‘no gain, no loss’ basis), Helen’s income is reduced by £30,000 to £95,000 and her husband’s income is increased by £30,000 to £70,000. This preserves Helen’s personal allowance, saving tax.
Strategy 3 – Give to charity
Making a donation to charity will also reduce adjusted net income. However, while this will enable an individual to preserve their personal allowance, they will obviously lose the benefit of the money donated to the charity.
Strategy 4 – Delay or accelerate income
It is also possible to preserve the personal allowance by delaying or accelerating payments to move them into another tax year. This strategy can be useful in a family company situation where the director is able to control the timing of bonus, salary and dividend payments.
Example 3: Delayed dividends
Ruby is the director of her personal company. In 2015/16 she plans to pay herself a salary of £10,000 and dividends of £110,000 (gross). Adopting this strategy will mean that her adjusted net income for the year will be £120,000 and as result she will lose most of her personal allowance.
However, by delaying dividend payments of £20,000 (gross) until after 5 April 2016 (thereby moving them into the 2016/17 tax year), her adjusted income for 2015/16 is reduced to £100,000 and her personal allowance is retained.
Practical Tip :
The abatement of the personal allowance where adjusted net income exceeds £100,000 results in marginal rates of tax of 60% on income in the £100,000 to £121,200 band. Various strategies can be adopted to reduce adjusted net income and to preserve the personal allowance to avoid paying tax at the effective 60% rate.
