Understanding the UK Personal Allowance

The concept of a personal allowance dates back to the early 20th century but was solidified by the Finance Acts of 1972 and 1973. There have been many changes and refinements to the personal allowance over subsequent years with the Government periodically making changes based on policy or to respond to prevalent economic conditions such as inflation.

The UK Personal Allowance plays a key role in the UK tax system in terms of how much of your hard earned money is subject to income tax, and therefore how much you can keep. In this post, we’ll examine the significance of the UK personal allowance and how you can optimise your tax position, but first let’s get a personal allowance definition.

What is the UK Personal Allowance?

The UK personal allowance is the amount of income you can earn each tax year before it becomes subject to income tax. In the current 2023/24 tax year the tax free personal allowance is £12,570 which means that typically the first £12,570 of your earnings won’t have income tax levied against them. If your total earnings are below this amount, they will not be subject to any income tax.

Any earnings above £12,570 will be subject to income tax at the applicable tax band based on your total income. Then Chancellor Rishi Sunak announced in the Spring Budget of March 2021 that the Personal Allowance threshold would be frozen at £12,570 until the 2025/26 tax year. Chancellor Jeremy Hunt then extended this freeze for a further 2 years in his Autumn 2022 Statement.

Understanding Personal Allowance and Tax Bands and Rates

Income that you earn above the personal allowance threshold will be subject to income tax. How much you earn determines which tax band you are in and therefore the percentage of tax levied on your earnings.

For the current 2023/24 tax year the income tax rates and bands are as follows:

  • Basic Rate Taxpayers – Taxable Income £12,571 – £50,270 – Tax Rate 20%
  • Higher Rate Taxpayers – Taxable Income £50,271 – £125,140 – Tax Rate 40%
  • Additional Rate Taxpayers – Taxable Income More Than £125,140 – Tax Rate 45%

Further Tax Allowances

Marriage Allowance

If you’re married or in a civil partnership you can take advantage of the marriage allowance to further increase your tax-free allowance. With the marriage allowance £1,260 of your personal allowance can be transferred to your spouse or civil partner.

To be eligible, however, one partner must be earning less than the £12,570 personal allowance threshold and the other must be a basic rate taxpayer. Transferring part of your personal allowance to your spouse or partner might increase the amount of tax you have to pay but can reduce your overall liability as a couple.

Blind Persons Allowance

The blind person’s allowance is an additional allowance to provide tax relief in addition to the personal allowance for people who are registered blind. In the 2023/24 tax year the blind person’s allowance is £2,870 which is added to the personal allowance giving a total tax-free amount of £15,440.

Dividend Allowance

If you receive part of your income through dividends you receive the first £1,000 of your dividends tax-free in the 2023/24 tax year thanks to the dividend allowance. Tax also isn’t paid on any dividends you receive that are within your personal allowance. In the 2024/25 tax year, the dividend allowance will reduce to £500.

How to Make the Most of Your Personal Allowance

Having an understanding of the personal allowance and its relationship with income tax bands as well as available tax reliefs and how you remunerate yourself all play a part in ensuring that you are operating as tax-efficiently as possible to maximise your income while remaining compliant.

Optimal Remuneration Structure

When you operate through your own limited company, dependent on your circumstances it can be advantageous to pay yourself a small salary within the personal allowance threshold of £12,570. This ensures that your income from salary is tax-free and you can then supplement this by paying yourself dividends. Dividends are company profits after tax that are distributed amongst shareholders and are taxed at a lower rate than income meaning that with the right structuring of your remuneration, tax savings can be made.

Tax-Efficient Investment

Usually you will have to pay income tax on interest and dividends earned from your savings and investments. By investing in pensions and ISAs you can benefit from further tax-efficiencies without impacting your personal allowance.

Strategic Timing of Your Income

Savvy contractors, freelancers and self-employed people may spread their income across two tax years or potentially delay receipt of windfalls or bonuses. This level of control in terms of income timing can enable you to keep your total income in a lower tax bracket or below the personal allowance threshold in a tax year all of which can contribute to reducing the tax liability that has to be paid.

Maximise Tax Reliefs, Allowances and Credits

It goes without saying that you should also claim all available tax reliefs, allowances and credits to ensure your business is operating as tax-efficiently as possible. Ultimately a reduced tax liability means bigger profit margins and better financial sustainability.

Work With an Accountant

In terms of ensuring you make the most of your personal allowance and all available tax breaks, it’s a good idea to appoint an accountant. With Gorilla, you’ll work with your own dedicated accountant who will be on hand to provide you tailored support, advice and guidance with a guaranteed same day response to ensure that your tax affairs and remuneration strategy are fully optimised.

You won’t have to worry about keeping abreast of any changes in UK tax allowances or legislation as your accountant will do this for you, and calculating your tax returns is a breeze thanks to FreeAgent accounting software which is free for all Gorilla Accounting clients.

If you have any queries about the personal allowance, your tax affairs or our accounting service, get in touch today on 0330 024 0406 or request a callback from an accountant.