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December 2018

The personal allowance which is the amount you can earn before income tax is set to rise in the 2018/19 tax year by £350, from £11,500 to £11,850. The basic rate threshold; the amount of earnings above the personal allowance that attracts income tax at 20%, will also rise by £1,000 to £34,500.

Whilst these changes may be welcomed by clients, and may improve take home pay for many basic rate tax payers, those who are on higher incomes may still not have recovered their losses as a result of the changes to tax thresholds which took place in the 2008/09 tax year.

Our Chartered Financial Planner Sheetal Radia looks a closer look at the income tax personal allowance.

Brief history of thresholds and allowancesFig 1. Personal allowanceFig 2. Basic rate tax threshold

The personal allowance has risen by 96% from the tax year 2008/09 to 2018/19 i.e. from £6,035 to £11,850 (Figure 1). As you can observe in Figure 2, the change in the basic rate threshold has not kept pace with the increases in the personal allowance. Over the same period this threshold has declined by c1% i.e. from £34,800 to £34,500. 

Keeping it real

So far, we have examined these changes in nominal terms i.e. without considering inflation. Over the same period inflation, as measured by the Consumer Price Index, rose by about 26%. Figure 3 shows what the basic rate threshold should have increased to had it have risen in line with inflation, compared to the actual threshold for the tax year 2018/19.

Fig 3. The real drag

As you can see (Figure 3), had the basic rate threshold kept up with inflation it would be almost £9,500 higher at £44,000 for 2018/19. This implies that with inflation adjustment there is a possibility you could earn up to £55,886 and remain a basic rate tax payer. However, under the actual allowances and thresholds the most you could earn and remain as a basic rate taxpayer is £46,350. Anyone earning above this amount e.g. £55,886 would have to pay 40% on the excess pay. In other words, the £9,536 additional income would incur an additional 20% tax.

Cumulative effects

Fig 4. Cumulative tax paid

In the tax year 2008/09, it was possible to earn up to £40,835 and remain a basic rate tax payer. Had the salary risen in line with inflation it would have reached a level of £51,673.31 in the tax year 2018/19. Since the basic rate threshold had not risen in line with inflation (in some years, it fell) over this period, this individual would have paid an additional total amount of tax of £9,091 (please see Figure 4). In other words, the individual would be taking home on average £910 less per annum. So far it appears that these individuals are unlikely to recover this additional tax.  

Key implications

As we have seen in this article, keeping an eye on inflation is important especially when headline changes to allowances and thresholds do not consider the rising cost of living over time. Making it even more vital for people to ensure that they consider the following to manage the tax they pay.

Pension contributions

  • Salary sacrifice – sacrifice some of your salary to reduce your taxable income for example increase your pension contributions.
  • Make personal contributions – if appropriate making personal pension contributions as a higher rate tax payer would after tax relief cost 60p for each £1 of contribution.

For additional rate tax payers the cost would reduce to 55p for each £1 of contribution.

Married or civil partnerships

If you are married or in a civil partnership ensure that you make use of your spouse/partner’s allowances e.g. pension contributions. Even a non-earning spouse or civil partner can contribute £3,600 each tax year and this includes £720 of tax relief meaning the net cost is £2,880.

Venture capital trusts

Where appropriate make use of investments in Venture Capital Trusts (VCTs) and/or Enterprise Investment Schemes (EISs) to reduce tax liabilities.