Personal Tax Allowance Trap

As you may be aware, one of the targets within the current coalition government was to raise the personal allowance to a limit of £10,000 within this parliamentary session. This process has been accelerated and will now come into force as from 06 April 2014. This sounds as though it is great news for everyone, as it appears as if no one will pay any tax on the first £10,000 of income in the tax year 2014/15. However, if an individual receives income in excess of £100,000 in the tax year then the personal allowance is reduced by £1 for each £2 of income in excess of £100,000.

60% Effective Income Tax Rate

So what does this mean for the people with income in excess of £100,000? It means that they have an effective income tax rate of 60% on any income between £100,000 and £120,000 in the tax year 2014/15 (between £100,000 and £118,880 in tax year 2013/2014). This is due to the 40% of higher rate income tax applied at this level, plus the loss of 20% of effective basic rate band allowance.

Penalty or Opportunity?

How can this be when the additional rate of income tax is meant to be 45% (as of 06 April 2013)? Surely a 60% effective rate of income tax is very punitive? Yes, I would have to agree that it is. So what can anyone do about this and try and mitigate this harsh effective tax band? The most immediate and effective option is to consider personal contributions into a pension scheme. If the spare capital and enough headroom within an individual’s maximum annual pension contribution allowance (£50,000 in 2013/2014) are available, then contributing an amount to effectively reduce one’s income to a level of £100,000 (or closer to it) for the tax year could be an extremely effective method of mitigating, and in fact capitalising on this effective tax rate band of 60%.

Summary

If this situation applies to you and you do have annual income in excess of £100,000, have you considered the benefits of engaging a professional Financial Planner to consider your options at these threshold points?

No individual advice has been provided during the course of this blog. The use of allowances and contributions into pensions should be planned for carefully and if you would like to receive individual advice on the topics above, then please contact the team at Chapters Financial Limited on 01483 578800.

Simon Hewitt BSc (Hons) Dip PFS
Financial Planner
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.
The Financial Conduct Authority does not regulate Tax advice.