When Do You Lose Your Personal Allowance?

The Personal Allowance is the amount of income you can earn each year without having to pay Income Tax. For most individuals in the UK, this threshold is currently set at £12,570 (for the tax year 2024-25). However, if your income exceeds a certain level, you may start to lose some or all of your Personal Allowance. Understanding when and why you lose your Personal Allowance is crucial for managing your tax liability effectively.

In this detailed guide, we will explain when you lose your Personal Allowance, how much you could lose based on your income, and strategies to reduce or manage the impact of a reduced allowance.

What Is the Personal Allowance?

The Personal Allowance is a tax-free amount that applies to most UK taxpayers. It allows you to earn up to a specific amount each tax year before you start paying Income Tax. For the 2024-25 tax year, the Personal Allowance is £12,570.

Any income earned above the Personal Allowance is subject to Income Tax at the basic, higher, or additional rate depending on your total income.

Income Threshold for Losing Your Personal Allowance

Once your income exceeds £100,000 in a tax year, your Personal Allowance starts to reduce. The reduction is £1 for every £2 of income you earn over £100,000.

This means that if you earn £125,140 or more in a year, your entire Personal Allowance will be lost, and you will be taxed on all of your income. Here’s a breakdown of how this works:

• Income under £100,000: You retain the full Personal Allowance of £12,570.

• Income between £100,001 and £125,140: Your Personal Allowance is reduced by £1 for every £2 you earn over £100,000.

• Income of £125,140 or more: You lose your entire Personal Allowance.

Example: How You Lose Your Personal Allowance

Let’s break this down with an example:

• If you earn £110,000, your income is £10,000 over the £100,000 threshold. This means you lose £5,000 of your Personal Allowance because it is reduced by £1 for every £2 you exceed the threshold.

  So, instead of having a £12,570 Personal Allowance, you now only have £7,570. You will pay Income Tax on the remainder of your income over £7,570.

• If your income is £125,140, your excess income over the £100,000 threshold is £25,140. Half of that amount is £12,570, which fully cancels out your Personal Allowance.

At this point, your entire income is subject to Income Tax, starting at the basic rate and moving into the higher and additional tax bands as appropriate.

Strategies to Reduce Income and Retain Your Personal Allowance

If your income exceeds £100,000, losing your Personal Allowance can significantly increase your tax liability. However, there are ways to reduce your taxable income and potentially retain some or all of your Personal Allowance. Here are a few strategies to consider:

1. Pension Contributions

Making contributions to your pension is one of the most effective ways to reduce your taxable income. Pension contributions can be deducted from your income, lowering the amount that counts toward the £100,000 threshold. By contributing more to your pension, you not only save for the future but may also be able to reclaim your Personal Allowance.

For example, if your income is £110,000 and you contribute £10,000 to your pension, your taxable income will be reduced to £100,000, allowing you to retain your full Personal Allowance.

2. Charitable Donations (Gift Aid)

Charitable donations made under Gift Aid can also reduce your taxable income. When you donate to a registered charity under Gift Aid, the charity can reclaim 25p from HMRC for every £1 you donate, and you can claim tax relief on the donation. This reduces your taxable income and can help bring your income below the £100,000 threshold.

3. Salary Sacrifice Schemes

If your employer offers salary sacrifice schemes—such as those for pensions, childcare vouchers, or cycle-to-work schemes—these can reduce your taxable income. Salary sacrifice involves giving up a portion of your salary in exchange for non-cash benefits, which can help you stay under the £100,000 threshold.

4. Spreading Income Over Multiple Years

If you have control over when you receive certain types of income, such as bonuses or dividends, you may be able to spread your income over multiple tax years to avoid exceeding the £100,000 threshold in any one year. This can help you retain your Personal Allowance and reduce your overall tax liability.

Impact of Losing the Personal Allowance

Losing your Personal Allowance can lead to a significant increase in your effective tax rate, especially for those whose income falls between £100,000 and £125,140. This is because the loss of the Personal Allowance creates a tax trap, where the marginal tax rate on this band of income effectively becomes 60%.

Here’s how this works:

• Income between £100,001 and £125,140 is taxed at the higher rate of 40%.

• Additionally, for every £1 of income in this range, you lose 50p of your Personal Allowance, which also adds a 20% tax effect.

• The combined impact is a 60% marginal tax rate on income in this band.

This high marginal rate makes it especially important for individuals in this income range to explore tax-saving strategies.

Is the Personal Allowance Tax-Free?

The income covered by the Personal Allowance is tax-free. As long as your income does not exceed £12,570 (for the 2024-25 tax year), you will not pay any Income Tax. However, once your income exceeds this threshold, you will be taxed at the applicable rates based on the amount by which your income exceeds the allowance.

For individuals earning more than £100,000, losing the Personal Allowance means that all of their income becomes taxable, starting at the basic rate of 20% and increasing to the higher rate of 40% and, in some cases, the additional rate of 45%.

How to Check Your Personal Allowance

If you are unsure whether you have lost part or all of your Personal Allowance, you can check by reviewing your tax code or accessing your Personal Tax Account through HMRC’s online services. Your tax code is a series of letters and numbers that indicates how much tax-free income you are entitled to.

For example, a tax code of 1257L means you have the standard £12,570 Personal Allowance. If your Personal Allowance has been reduced due to high income, your tax code may reflect a lower number.

Summary

In the UK, the Personal Allowance is a valuable tax-free threshold that allows you to earn up to £12,570 without paying Income Tax. However, if your income exceeds £100,000, you start to lose your Personal Allowance at a rate of £1 for every £2 you earn over the threshold. This reduction continues until your income reaches £125,140, at which point you lose your entire Personal Allowance.

Losing your Personal Allowance can significantly increase your tax liability, particularly if your income falls between £100,000 and £125,140, where the marginal tax rate can reach 60%. However, by using strategies such as pension contributions, charitable donations, and salary sacrifice schemes, you may be able to reduce your taxable income and retain your Personal Allowance.

Understanding how the Personal Allowance works and when you might lose it is crucial for managing your finances effectively and ensuring that you pay the right amount of tax.