What is the Personal Allowance?

The Personal Allowance is a key element of the UK tax system that allows individuals to earn a certain amount of income each year before they are liable to pay Income Tax. Understanding the Personal Allowance is essential for managing your personal finances effectively and ensuring you’re not paying more tax than necessary. In this detailed guide, we’ll explore what the Personal Allowance is, how it works, who qualifies for it, and how you can make the most of it.

What is it?

The Personal Allowance is the amount of income you can earn before paying any Income Tax. For the tax year 2024-25, the standard Personal Allowance remains at £12,570, meaning that any income you earn up to this threshold is not subject to Income Tax.

The Personal Allowance is available to most individuals in the UK, whether you’re employed, self-employed, or retired. It applies to earnings from various sources, including wages, pensions, savings interest, and rental income.

Once your income exceeds the Personal Allowance threshold, you will start paying tax on the amount above £12,570. The rate at which you pay tax depends on your income and which tax band you fall into:

• Basic rate (20%): For income between £12,571 and £50,270.

• Higher rate (40%): For income between £50,271 and £125,140.

• Additional rate (45%): For income over £125,140.

Who Qualifies?

Most UK taxpayers are entitled to the standard Personal Allowance. This includes:

• Employees: Those working for an employer and earning a salary.

• Self-employed individuals: Those earning an income from their own business or freelance work.

• Retirees: Those receiving a pension from the state or private pension schemes.

However, if your income exceeds £100,000, your Personal Allowance starts to reduce. For every £2 of income over £100,000, your Personal Allowance is reduced by £1. This means that if your income reaches £125,140 or more, you lose your entire Personal Allowance and will be taxed on your full income.

How it Works

The Personal Allowance operates as a tax-free threshold, allowing you to keep more of your earnings before tax kicks in. Here’s an example of how it works:

If you earn £30,000 in the 2024-25 tax year, your taxable income would be calculated as follows:

£30,000 (income) - £12,570 (Personal Allowance) = £17,430 (taxable income)

The £17,430 would be taxed at the basic rate of 20%, which means you would pay £3,486 in tax.

For individuals with income over £100,000, the tapering effect comes into play, reducing your allowance based on how much you earn over the threshold.

Personal Allowance and Marriage Allowance

If you are married or in a civil partnership and one of you earns less than the Personal Allowance threshold, you might be able to benefit from the Marriage Allowance. This allows the lower-earning partner to transfer up to £1,260 of their unused Personal Allowance to their partner, potentially reducing their tax bill by up to £252 in the tax year.

To be eligible for the Marriage Allowance:

• One partner must earn below the Personal Allowance threshold (£12,570).

• The other partner must be a basic-rate taxpayer (earning between £12,571 and £50,270).

This is a valuable way for couples to maximise their tax efficiency and reduce their overall tax liability.

Blind Person’s Allowance

Individuals who are registered blind or severely sight-impaired are eligible for the Blind Person’s Allowance. This adds an additional £2,870 to their Personal Allowance, allowing them to earn up to £15,440 tax-free.

If you are married or in a civil partnership and cannot use all of your Blind Person’s Allowance, you can transfer the unused portion to your spouse or civil partner.

Maximising Your Personal Allowance

There are several ways to maximise your Personal Allowance and reduce your overall tax liability:

1. Marriage Allowance: If you and your partner are eligible, make sure to claim the Marriage Allowance to reduce your combined tax burden.

2. Pension Contributions: Contributions to a pension scheme can reduce your taxable income, helping you to stay below the higher tax bands or even reclaim some of your Personal Allowance if your income exceeds £100,000.

3. Charitable Donations: Donations made through Gift Aid reduce your taxable income, potentially allowing you to maximise the use of your Personal Allowance.

4. Use of ISAs: Invest in Individual Savings Accounts (ISAs), which allow you to earn interest, dividends, or capital gains without impacting your Personal Allowance or being subject to tax.

Other Allowances That Work Alongside the Personal Allowance

Personal Savings Allowance

In addition to the Personal Allowance, most taxpayers are entitled to the Personal Savings Allowance, which allows them to earn tax-free interest on savings.

• Basic-rate taxpayers can earn up to £1,000 in tax-free savings interest.

• Higher-rate taxpayers can earn up to £500.

• Additional-rate taxpayers are not entitled to a Personal Savings Allowance.

Dividend Allowance

If you receive income from dividends, the Dividend Allowance applies. For the 2024-25 tax year, you can receive up to £1,000 in tax-free dividends. Dividends above this amount are taxed at different rates depending on your income band.

• Basic rate: 8.75%

• Higher rate: 33.75%

• Additional rate: 39.35%

Trading and Property Allowances

For individuals earning a small amount of extra income from self-employment or property, the UK offers the Trading Allowance and Property Allowance, both of which allow up to £1,000 in tax-free income.

Is the Personal Allowance Tax-Free?

The income covered by your Personal Allowance is tax-free. This means you do not pay Income Tax on the first £12,570 of your earnings, whether from employment, self-employment, or other sources such as pensions.

However, if your total income exceeds the Personal Allowance, the excess will be taxed based on the applicable tax bands.

Summary

The Personal Allowance is an essential part of the UK’s tax system, allowing individuals to earn up to £12,570 tax-free each year. While most people benefit from this allowance, higher earners may see their Personal Allowance reduced if their income exceeds £100,000.

Maximising your Personal Allowance through methods like Marriage Allowance, pension contributions, and charitable donations can help you reduce your tax liability. Understanding the interplay between your Personal Allowance and other tax allowances, such as the Personal Savings Allowance and Dividend Allowance, is key to optimising your tax efficiency.

By making informed decisions about your income, savings, and investments, you can ensure you are using the Personal Allowance to your full advantage and keeping your tax bills as low as possible