Personal Allowance – Do I lose it if I earn over £100k?
The Personal Allowance is the amount of income an individual can earn before they start to pay Income Tax but it will be reduced and potentially lost altogether for those whose total income exceeds £100,000.
The Personal Allowance (under age 65) is currently £11,000 but you will lose £1 of Personal Allowance for every £2 of Income over £100,000. Anyone with income over the £122,000 (£11,000 x 2) will lose their entire allowance.
As a consequence the Marginal Rate of Tax for someone with income between £100,000 and £122,000 will be 60% (Tax at 40% on income over £100,000 up to £122,000 PLUS Tax at 40% on the loss of Personal Allowance up to £11,000).
You can recover the Personal Allowance by reducing your income below the £100,000 limit. Apart from asking your employer to pay you less (not a sensible or popular decision, it may save Tax at 60% but you still lose out on the remaining 40%) the only viable option to consider is a Pension Contribution.
Your total income is expected to be £112,000 i.e. you have £12,000 of income over the £100,000 and in effect you are losing £6,000 of your Personal Allowance.
If however you invested a gross amount of £12,000 into a pension it would reduce your income to £100,000, thus restoring your Personal Allowance.
The pension investment will qualify for Basic Rate Relief at source and so to invest a gross amount of £12,000 a pension would only cost you £9,600.
You would then be eligible for a further 20% Tax Relief (representing the Higher Rate Tax Relief). This is claimed via your Self-Assessment Tax Return and you would end up with a Tax Rebate of £2,400.
Overall it has cost you £7,200 to invest £12,000 into the pension. But in addition you will regain the lost £6,000 of Personal Allowance which gives you a further Tax Saving of £2,400 (£6,000 x 40%). It could therefore be argued that the cost of the £12,000 gross pension contribution is £4,800 (£7,200 – £2,400).