So You Want to Understand Your Personal Allowances?

1949: Any Number Can Play - LeRoy

Sadly I have not mastered a way to put a graphic into this blog - which would help enormously to portray what really happens to personal allowances and rates of income tax. This is for everyone under 65 - sorry I know many of my clients are over 65, but the Government are intending to scrap the age allowance anyway and this is really a post about the mechanics of tax.

Now (2011/12)

Personal Allowance £7,475 = 0% tax

The next £35,000 (total income up to £42,475) = 20%

The next £57,525 (total income up to £100,000) = 40%

The next £14,950 (total income up to £114,950) = 60%

The next £35,050 (total income up to £150,000) = 40%

Everything above £150,000 = 50% 

New Tax Year (2012/13)

Personal Allowance £8,105 = 0% tax

The next £34,370 (total income up to £42,475) = 20%

The next £57,525 (total income up to £100,000) = 40%

The next £16,210 (total income up to £116,250) = 60%

The next £33,750 (total income up to £150,000) = 40%

Everything above £150,000 = 50%

Budget Announcement (2013/14)

Personal Allowance £9,205 = 0% tax

The next  £32,245 (total income up to £41,450) = 20%

The next  £58,550 (total income up to £100,000) = 40%

The next £18,410 (total income up to £118,410) = 60%

The next £31,590 (total income up to £150,000) = 40%

Everything above £150,000 = 45%

So if you follow this (well done!) the amount of income you need to earn before paying 40% tax is falling (from £42,475 to £41,450). Let's do a worked example. Suppose you earn £160,000 a year and your income remains fixed.

2011/12 the actual tax (excluding any National Insurance) would be £58,000, in 2012/13 £58,126 and in 2013/14 £58,051. This is what I mean by moving the goalposts - the reality is that you end up about the same (in this example), even though at first reading it looks as though you may be a bit better off as the personal allowance has risen.

Suppose you earn £65,000 well this tax year you would pay tax of £14,010, in 2012/13 you would pay £13,884 and in 2013/14 you would pay £13,869. Not exactly massive sums, which is the point, because the Chancellor/Government/Country cannot really afford to reduce tax in the current climate, at least not for those who are generally 40% taxpayers.

This is not a political statement, its simple fact (all Chancellors play this game because they are head of the Treasury, which is a Civil Service department). Its also true that we do have a 60% rate of tax (effectively) as well as the 50%, but this only applies to those caught earning a bit above £100,000.

Of course a good financial planner will know how to help you reduce your tax liability legitimately, but tax is only an aspect of financial planning, not the main purpose.