Understanding Your Personal Tax Allowance: Beyond the Numbers, It's about Policy and Your Choices

 
Personal Tax Allowance

 

The personal tax allowance – currently £12,570 – lets you earn a portion of your income tax-free each year. It might seem straightforward, but this figure plays a crucial role in government economic policy, shapes income distribution, and impacts your individual tax liability. Let’s dive beneath the surface.

How Your Personal Tax Allowance Works

Your personal tax allowance is the bedrock of how much income tax you pay. Let’s break it down with real-life examples:

Scenario 1: Full Allowance

  • If you earn £10,000 in the 2023/24 tax year, you fall entirely within the personal allowance of £12,570. Congratulations, you owe no income tax!

Scenario 2: Taxable Income After Allowance

  • Let’s say you earn £20,000. The first £12,570 is protected by your allowance, leaving only £7,430 as taxable income. You’ll owe income tax on that £7,430.

Scenario 3: Stepping into Higher and Additional Rate Taxes

  • Imagine your taxable income (after that allowance) climbs above £50,270. Every pound over that amount means you’ll face the 40% higher-rate tax. If your taxable income rises beyond £125,140, the top slice will be taxed at an even higher 45% rate.

Consider what happens when your income climbs over £100,000. For every £2 above this threshold, your personal allowance shrinks by £1 until it finally disappears at £125,140.

Individuals in this income bracket can face a startling effective tax rate of up to 60% on certain earned income, like bonuses.

Example: When a Bonus Backfires

Bert earns £100,000 in salary and then gets a £7,000 bonus. Due to exceeding the £100,000 income limit, he loses £3,500 of his personal allowance. He will owe £2,800 of tax on the bonus as usual (40%), but he also has to pay an extra £1,400 (40% of the lost allowance). Thus, his bonus carries a whopping 60% effective tax rate!

Compare Bert to Charlie, who earns £125,000 from his job. Charlie already has no personal allowance, so receiving the same £7,000 bonus carries a much lower effective tax rate of just 40%.

Remember: It’s not your overall salary, but your income after the allowance that pushes you into these higher tax rates.

Here you can quickly calculate how much tax you need to pay on your income.

Other Factors Affecting Your Allowance: When It’s Not Standard

Here’s where it gets a bit more complicated:

  • Age Allowance: If you were born before April 6th, 1948, you might have a larger “age allowance” which boosts your tax-free threshold.
  • Blind Person’s Allowance: If you are registered blind, you get a further “blind person’s allowance” to increase the amount of income that’s untaxed.
  • Marriage Allowance: The Benefits of Partnership: A perk for married or civilly partnered couples where one person earns low/no income and the other pays basic-rate tax. Here, you can transfer up to £1,260 of unused allowance to your partner, saving up to £252 in reduced taxes.

Your Tax Code: The Clues Are On Your Payslip

Found on your payslip or P45, this code, like ‘1257L’, helps your employer figure out how much to deduct in income tax. The ‘1257’ bit usually mirrors the standard allowance, but can change if you have extra allowances or deductions. A wrong code can mean overpaying or underpaying tax – so checking it carefully is key!

Claiming Tax Relief: Perks that Shrink Your Taxable Income

Beyond the basic allowance, certain expenses get categorised as ‘tax relief’, deducting their cost from your income before it faces tax. This means less tax on the same income!  These reliefs can include:

  • Job-Related Expenses: Things your work requires, but doesn’t reimburse
  • Work from Home Expenses: Potential allowance if your employer makes you work from home
  • Charitable Donations through Gift Aid: Amplify your good deeds, charity gets more!
  • Pension Contributions: Slash your tax, prep for retirement

Beyond Your Bank Account: Wider Economic Effects

  • Spending vs. Inflation: When the allowance rises, people have more spending power. However, economists fiercely debate whether this fuels excessive spending, potentially driving inflation.
  • Targeting Support: Increasing the allowance helps lower-income earners the most. But is this the fairest, most targeted way to combat the cost-of-living squeeze, or might other measures, like adjustments to benefits, be better?
  • Redistribution Debate: That disappearing allowance for top earners isn’t an accident. It’s a way to redistribute income. Supporters argue it promotes fairness, while opponents say steep marginal rates discourage hard work and innovation.

It’s Not One-Size-Fits-All: Potential Inequality

  • The Self-Employed Gap: Self-employed individuals miss out on the same generous blanket allowance. Does this gap need addressing to boost the entrepreneurial spirit that benefits the broader economy?
  • Age Matters: Older taxpayers may enjoy larger allowances. Is this fair given the unique financial burdens, like sky-high property prices, younger generations face?
  • Marriage Muddle: Marriage Allowance helps some couples, but could it disadvantage unmarried individuals or fail to reflect modern relationship trends?

Think Strategy, Act Tactically

See the economic implications of your allowance, but don’t neglect the smaller actions for immediate improvement: check your tax code, seek out underused reliefs, and be shrewd with financial planning. This can keep more of your hard-earned cash where it belongs.

Expert Assistance Can Pay Off

Tax is complex! If you’re unsure about maximising your allowances or want personalised advice on your circumstances, accredited tax advisors like TaxAce Ltd are here to help. We’ll analyse your unique situation and identify all tax-saving opportunities.

Contabila UK - Founder and CEO -TaxAce - Iurie Bivol

Iurie Bivol

Director TAXACE LTD

Entrepreneur and accountant with 15 years of experience in the UK.

Contabilitate UK - Senior Tax Assistant - Alina Costreie

Let's talk accountancy services for business.

Like what you see? Get in touch today to see how we can help you save time and stress less.