The personal allowance is set at £12,570 for 2023/24. However, not everyone is able to benefit from the personal allowance.
A taper applies which gradually reduces the personal allowance until it is lost. The taper applies when adjusted net income exceeds £100,000. It operates by reducing the personal allowance by £1 for every £2 by which adjusted net income exceeds £100,000.
William has an adjusted net income of £110,000 for 2023/24.
As his adjusted net income exceeds £100,000, his personal allowance is reduced.
At £110,000, his income exceeds £100,000 by £10,000. The taper reduces his personal allowance by £1 for every £2 of the excess – a reduction of £5,000. Consequently, William will only receive a personal allowance of £7,570 for 2023/24 (£12,570 – £5,000).
The personal allowance is lost in its entirety once adjusted net income reaches £125,140.
The taper threshold has remained unchanged at £100,000 since its introduction, bringing more people within its scope as wages rise due to inflation.
60% marginal rate of tax
The combined impact of the personal allowance taper and the higher rate of tax (at 40%) applying in this band means the marginal rate of tax between £100,000 and £125,140 is 60%. It drops to 45% (the additional rate) once income reaches £125,140.
A 60% marginal rate of tax is a high rate. However, when National Insurance contributions, pension contributions and student and post-graduate loans are taken into the mix, the marginal rate of deduction in this zone can climb to 80%.
Preserving the allowance
There are some steps that can be taken to preserve the personal allowance where income falls in the abatement zone.
Option 1 – timing
Where it is possible to control the timing of payments, as may be the case in a personal or family company, consideration can be given to deferring income so that it is received in 2024/25 instead. This will be useful if it will reduce income in 2023/24 such that either the personal allowance is preserved or less of it is lost, without triggering the taper in 2024/25.
Deferring £15,000 of income so that adjusted net income is £105,000 in 2023/24 rather than £120,000 will mean that the personal allowance is £10,070 in 2023/24 rather than £2,570.
Option 2 – pension contributions
Making pension contributions can be tax-efficient, with the added benefit of building up funds for retirement. The increase in the annual allowance to £60,000 for 2023/24 and the abolition of lifetime allowance charges pave the way for making higher pension contributions in 2023/24. Making a pension contribution of £30,000 to reduce adjusted net income from £130,000 to £100,000 will recover the personal allowance in full. The contribution will also attract tax relief.
Option 3 – donations to charity
Individuals who want to make charitable donations can take advantage of the gift aid rules to make charitable gifts while reducing their adjusted net income and preserving their personal allowance.