Allocation of Personal Allowance

As it is generally known, the Personal Allowance (“PA”) can be offset in the most beneficial manner for the taxpayer. In the past, this followed a fairly rigid structure, i.e. you allocated the PA first to the non-savings income, followed by the savings income and finally against the dividend income.

However, due to introduction of the 0% rate bands (namely the 0% savings starting rate of £5,000, savings allowance of up to £1,000 and the dividend allowance of £5,000), the allocation of the PA that we all were used to, in some cases, is no longer applicable.

It therefore may be more beneficial to allocate some of the PA to dividends falling in the higher rate band to increase tax at the basic rate (e.g. more non-savings or savings income being taxed at 20%), but to reduce tax at the higher dividend rate (less dividend income being taxed at 32.5%) giving us a tax savings of 12.5%.

Let’s have a look at two examples (calculations are based on 2016/17 tax rates and allowances).

Example 1

The taxpayer received a salary of £38,000 and a dividend income of £10,000. Following the “old” allocation would result in a tax bill of £7,025:

TotalNon-savingsDividends
Total income£48,000.00£38,000.00£10,000.00
Less: PA-£11,000.00-£11,000.00£    –
Income after PA£37,000.00£27,000.00£10,000.00
Dividend allowance-£5,000.00
Taxable income£ 27,000.00£ 5,000.00
Taxed @20%32.5%
Tax Liability £7,025.00 £5,400.00 £1,625.00

However, when using the “new” allocation the tax bill will amount to £6,400, giving a tax saving of £625):

TotalNon-savingsDividends
Total income£48,000.00£38,000.00£10,000.00
Less: PA-£11,000.00-£6,000.00-£5,000.00
Income after PA£37,000.00£32,000.00£5,000.00
Dividend allowance *-£5,000.00
Taxable income£32,000.00£     –
Taxed @20%32.5%
Tax Liability £6,400.00 £6,400.00 £ –  

 

Example 2

Taxpayer received a pension income of £8,500, savings income of £6,500 and the dividend income of £10,000. Following the “old” allocation would result in a tax bill of £375:

TotalNon-savingsSavingsDividends
Total income£25,000.00£8,500.00£6,500.00£10,000.00
Less: PA-£11,000.00-£8,500.00-£2,500.00£-
Income after PA£14,000.00£-£4,000.00£10,000.00
Savings/Dividend allowance-£1,000.00-£5,000.00
Taxable income£-£3,000.00£5,000.00
Taxed @20%0%7.5%
Tax Liability £375.00 £-   £-   £375.00
Savings income of £3000 is covered by the 0% savings starting rate

However, when using the “new” allocation the tax bill will amount to £225, giving a tax saving of £150:

TotalNon-savingsSavingsDividends
Total income£25,000.00£8,500.00£6,500.00£10,000.00
Less: PA-£11,000.00-£8,500.00-£500.00-£2,000.00
Income after PA£14,000.00£-£6,000.00£8,000.00
Savings/Dividend allowance-£1,000.00-£5,000.00
Taxable income£-£5,000.00£3,000.00
Taxed @20%0%7.5%
Tax Liability £225.00 £-   £-   £225.00
Savings income of £5000 is covered by the 0% savings starting rate

 

Although the increasing number of rates and allowances is making our tax system more complicated, it also gives some comfort that in certain circumstance taxpayers can save money by allocating their personal allowance in the manner that is the most beneficial to them, and not to the Taxman.

Blog written by: Anshu Diddee

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