Written by Tina Winter
Back in the day, income tax personal allowances were simple animals, and it was fairly clear cut whether you were entitled to them or not. Tax legislators have complicated personal allowances over recent years causing traps for the unwary, both in regards to taxpayers effectively becoming subject to very high marginal rates of tax, and also the poor exam student having to carry out complex calculations in exams like the CII’s CF2, R03, J01 and AF1.
Personal Allowance Trap
For tax year 2011/12 (examined by the CII until 31 August 2012), the personal allowance was gradually reduced to nil where adjusted net income exceeded £100,000, by £1 for every £2 excess. Adjusted net income is net income less the gross amount of personal pension contributions and gift aid donations. Where this figure falls between £100,000 and £114,950, the effective marginal rate of income tax is a staggering 60% – this is higher rate at 40% plus an additional 20% as a result of the withdrawal of the personal allowance. A quick tip here to aid calculations – £14,950 is twice the personal allowance figure, £7,475.
Age Allowance Trap
This is a similar situation to the personal allowance trap in that age allowances are progressively withdrawn if income is above a certain limit, which was £24,000 for 2011/12 (examined by the CII until 31 August 2012), again at a rate of £1 for every £2 of total gross income above the limit. The reduction is made first to the personal allowance until it falls to the amount for an individual under 65 – £7,475 for 2011/12. Any further reduction is then made to the married couples allowance down to the basic amount of £2,800. The effective marginal rate at income levels where the age allowance is withdrawn is 30%, and where married couple’s allowance is withdrawn is 25%.
Individuals who find they have fallen into these traps can, to some extent, take action to reduce their effect and some of these methods are shown below:
- Make use tax free investments – ISAs, National Savings Certificates – as far as possible
- Make maximum pension contributions and gift aid contributions to reduce adjusted net income for personal allowance purposes
- Defer cashing single premium bonds where income is slightly in excess of the limits where allowances start to be withdrawn
Good luck with your exams!