Navigating Your Personal Tax Allowance
As a conversation topic, tax is quite unique, capable as it is of being both sleep inducing and exciting the fiercest of passions.
Most people also find they have an ambiguous relationship with tax. When it boils down to it, no one likes giving their hard won earnings away. But there is also a widespread recognition of the important role tax plays in funding public services, which has lead to a lot of sensitivity around the issue of tax avoidance, and worse, evasion.
Ultimately, all everyone really wants is a level playing field, where the different rates and allowances are transparent and fair, and everyone pays accordingly. Unfortunately, the peculiar complexities of the tax system can be a obstacle to this.
In many ways, business taxes are more straightforward than personal taxes. Yes, PAYE can be complex from an administrative point of view, and VAT can be a minefield. But at least Corporation Tax is easy enough, with a nice flat 19 per cent rate on profits for everyone.
Not so with your personal taxes. With different rules and rates depending in whether you class as self-employed or employed, and whether you draw a salary from your business or take earnings in the form of share dividends, tax on personal income can be a minefield.
Added to that, the rules have a tendency to change regularly, creating more confusion in terms of what you are entitled to offset and what you are obliged to pay. Here are two examples of key changes to personal income tax rules introduced last year, to dividends and to tax deductible pension contributions.
In April 2016, the tax regulations on dividends changed. The previous system of an automatic 10 per cent tax credit on all dividend earnings was replaced by a system which treats dividends as gross income. The changes also brought dividends in line with the income tax allowance and rate thresholds. In 2017/18, these thresholds are:
- Tax-free Personal Allowance – £11,000
- Basic/Ordinary Rates – earnings up to £33,500
- Higher/Upper Rates – £33,500 – £150,000
- Additional – over £150,000.
There is a separate £5,000 tax free allowance on dividends, but unlike the main personal allowance this is still counted as part of your gross income. If, for example, you earn £50,000 in overall gross income, tax is only liable on £39,000 overall because of the £11,000 personal allowance. If some of that balance happens to be in the form of dividends, your tax rates are still calculated on the total of £39,000 – you just don’t pay any tax on the first £5000 worth of dividends.
Compared to the previous system, dividend earnings now attract more tax, and must be declared by filling in a self-assessment tax return. But with ordinary and upper rates of 7.5 and 32.5 per cent, compared to the basic and higher Income Tax rates of 20 and 40 per cent, dividends still represent a sound way to reduce personal tax liabilities for business owners, directors and investors alike.
Dividends earned through ISAs and pension funds are still tax free.
Pension Scheme Allowances
Pension contributions have long offered a means of offsetting tax liabilities through Income Tax relief, but as with dividends, the regulations changed in April last year. The existing system of fixed rate relief on gross pension contributions up to £40,000 per annum is still there, but for higher earners, there is now a ‘tapered’ scale which reduces permissible contributions down to a minimum of £10,000 depending on income.
This tapered allowance is triggered if your threshold income – essentially the total income you receive from all qualifying sources – exceeds £110,000 a year. At this point, your threshold income plus the value of any pension savings you have – your adjusted income – is taken into consideration. If your adjusted income amounts to £150,000 or more, then the amount of pension contributions you can make to offset against tax starts to be reduced.
When your adjusted earnings reach £210,000, you reach the end of the ‘taper’, and pension contributions to offset against tax are capped at £10,000.
As with all areas of financial planning, it is always recommended to seek impartial, specialist professional advice when considering personal tax. Fiducial Wealth offers a broad range of award-winning personal and corporate financial and wealth management services. Visit www.fiduciawealth.co.uk for more information.