When discussing income tax in the UK, one term that frequently comes up is “personal allowance”. But what exactly is it, and why is it important? Let’s break it down.
What is the Personal Allowance?
Your personal allowance is the amount of income you can earn each tax year before you start paying income tax. Everyone receives the personal allowance. For the 2024/25 tax year, this amount is set at £12,570. This means that if your income is £12,570 or less, you won’t pay any income tax on it.
How Does It Work?
Imagine you earn £30,000 a year. The first £12,570 of that income is your personal allowance and is tax-free. The remaining £17,430 is what you’ll pay tax on, based on the tax bands of the country that you are resident in. These bands and rates vary slightly between Scotland and the rest of the UK, but the concept remains the same: personal allowance reduces the amount of your income that is subject to tax.
Where you are in employment, your personal allowance will usually be offset against your earned income. This is done through your tax code, with an equal element of the allowance being allocated to each pay period. You might want to read our blog which explains how to check your tax code.
The personal allowance can be offset against all income, so for instance, if you do not have enough earned income to use up your allowance, then it can be offset against other income such as dividends, interest and pensions.
The Impact on Your Take-Home Pay
When you are receiving your personal allowance through your pay, the tax you pay is being reduced at source. If your allowance isn’t being used in full this way, then you will be able to offset any unused balance against other income. You may need to file a tax return to do this correctly.
If you are a business owner and your spouse or partner isn’t fully using their allowance, then it’s worth considering if they could be doing some work for you. As long as you pay them a market rate for the work they are doing (not an inflated one) then you can effectively use up their tax free allowance.
If it is a limited company which you have, this can reduce your corporation tax bill (if you pay them a salary) and allow you to increase the money coming into the family household without increasing personal tax. That’s because if you don’t pay more than the allowance, there is no income tax to pay. Even if you pay a salary above the personal allowance it may still be beneficial if your spouse pays tax at a lower rate than you do. You can reduce your salary and increase the one for your spouse / partner so that you are receiving the funds at a lower tax rate.
Get In Touch
If you are not sure that you are using your household personal allowances in the most effective way, give us a call and we can talk you through the options.
And Finally………
Your children each have their own personal allowances. You can get them working in the family business and pay them pocket money through the payroll, which saves you paying it out of your after tax income!
You may be thinking that you could gift your children some of your income-producing assets, like savings or investments so that you can avoid the tax you pay on them. That won’t work. Unless the income generated is less than £100, the income is still treated as the income of the parents. The £100 applies to each parent and is known as the £100 rule. It doesn’t apply to gifts from grandparents or other relatives.
