Paying less tax is something every taxpayer aspires to achieve. The good news is that the UK tax system provides several ways to reduce your tax bill legally by maximizing your Personal Allowance and making use of available reliefs and deductions. This detailed guide explains how to get the most from your Personal Allowance and other strategies to keep more of your hard-earned money in your pocket.
What is the Personal Allowance?
The Personal Allowance is the amount of income you can earn each tax year before paying any Income Tax. For the 2024/25 tax year, the standard Personal Allowance is £12,570. This means that the first £12,570 of your income is tax-free, and tax is only due on earnings above this threshold.
Understanding Income Bands and Tax Rates
After your Personal Allowance is deducted, the rest of your income is taxed at different rates depending on how much you earn:
- Basic Rate (20%): On income between £12,571 and £50,270.
- Higher Rate (40%): On income between £50,271 and £125,140.
- Additional Rate (45%): On income over £125,140.
Maximizing your Personal Allowance means keeping as much of your income as possible in the 0% band and managing your income to avoid higher tax rates where possible.
How Income Affects Your Personal Allowance
If your income exceeds £100,000, your Personal Allowance is gradually reduced by £1 for every £2 of income over that limit. This means that by the time your income reaches £125,140, you lose the entire Personal Allowance, creating an effective marginal tax rate of 60% on income between £100,000 and £125,140. Careful planning is needed to avoid or mitigate this high tax rate.
Strategies to Maximize Your Personal Allowance
Here are some practical ways to make the most of your Personal Allowance and reduce your overall tax bill:
1. Use Marriage Allowance
If you’re married or in a civil partnership and one partner’s income is below the Personal Allowance threshold while the other is a basic rate taxpayer, you can transfer up to 10% of your unused Personal Allowance to your partner. This can save up to £252 a year in tax (for the 2024/25 tax year).
2. Make Pension Contributions
Contributions to a personal pension or occupational pension scheme reduce your taxable income. This can help bring your income below the £100,000 threshold if you’re close to losing your Personal Allowance, effectively restoring part or all of it. Pension contributions also benefit from tax relief at your highest marginal rate, making them one of the most tax-efficient ways to save.
3. Donate to Charity via Gift Aid
Charitable donations under Gift Aid extend your basic rate band, reducing the amount of income taxed at higher rates. For higher and additional rate taxpayers, this also means you can claim back additional tax relief through your Self Assessment tax return. Donations can also help bring your income back under the £100,000 threshold, protecting your Personal Allowance.
4. Manage Your Investment Income
Use tax-free allowances like the £500 or £1,000 savings allowance (depending on your tax rate) and the £500 dividend allowance to shield income from tax. Investing within an Individual Savings Account (ISA) ensures that interest, dividends, and capital gains are completely tax-free.
5. Spread Income Between Spouses
If you’re married or in a civil partnership, consider splitting income-producing assets so that each partner makes full use of their Personal Allowance and lower tax bands. This is especially helpful if one partner is a non-taxpayer or basic rate taxpayer.
6. Claim Allowable Deductions and Expenses
Depending on your circumstances, you may be able to claim deductions such as professional fees, subscriptions, or work-related expenses that reduce your taxable income. This can help keep your income below the threshold at which your Personal Allowance is reduced.
Impact of Benefits and Tax Credits
Some means-tested benefits and tax credits are affected by your taxable income. By using the strategies above to reduce your taxable income, you might also become eligible for certain benefits or increase the amount you receive.
Practical Example
Let’s look at an example to illustrate how this works:
Jane earns £105,000 a year. She would lose £2,500 of her Personal Allowance (£1 for every £2 over £100,000). However, if she makes a pension contribution of £5,000, her taxable income falls to £100,000, restoring her full Personal Allowance and saving her significant tax.
Self Assessment and Reporting
If you are required to file a Self Assessment tax return (for example, if you are self-employed or have other untaxed income), you should report all relevant income and deductions. Pension contributions, charitable donations, and other reliefs must be correctly entered to ensure you receive the tax relief you’re entitled to.
Keeping Good Records
To substantiate your claims and protect yourself from HMRC enquiries, it’s essential to keep accurate records of:
- Pension contributions (statements and certificates).
- Gift Aid donations (charity receipts and declarations).
- Investment income statements.
- Employment expenses (if claimed).
Getting Professional Advice
Tax planning can be complex, especially when your income fluctuates or crosses key thresholds. Consulting a tax adviser or accountant can help you navigate the rules, avoid errors, and maximise your savings. Professional advice is particularly important if you have multiple sources of income or investments.
Conclusion
Maximizing your Personal Allowance is a key strategy to reduce your UK tax bill. By understanding how income affects your allowance and using tools like pension contributions, Gift Aid, Marriage Allowance, and ISAs, you can legally minimize the tax you pay. Staying informed and taking proactive steps throughout the year helps ensure you’re making the most of the reliefs and allowances available to you. For complex situations, professional advice can make all the difference.
