The financial planning implications of Nick Clegg’s proposed rise in the personal allowance

18th November 2013

The Deputy Prime Minister is calling for the personal allowance to be increased to £10,500, some £500 more than the rise currently on the cards.

With the Autumn statement due in early December a bidding war is starting among both Coalition partners to claim the credit for raising the limit. Certainly, the Chancellor George Osborne is expected to back Clegg’s call according to the Independent.

Financial experts say it will also make pension planning a lot easier too.

Danny Cox, Head of Financial Planning, Hargreaves Lansdown says: “Increasing the personal allowance to £10,500 makes a lot of sense and makes the system a little simpler: £10,500 is the level of State Pension plus age related allowance for those who currently receive it. The last increase in personal allowance was by £1,335 and the scheduled increase of £560 seems somewhat miserly in comparison. The stated longer term aim to increase the personal allowance to £12,500 supports a larger rise now.”

Despite calls for a rise on the threshold for higher rate tax from some Conservative MPs, HL believes that the rise is likely to be paid for an increase in the higher rate tax threshold.

The firm says it makes it all the important to make use of personal allowances in pension planning and calculated how a change in the limit could affects things.

· Couples should ensure they are making full use of both their allowances by having sufficient taxable income in each name. One of the best ways to do this is with pension income:

Based on personal allowance of £10,000, an individual could have a pension fund of £162,742 and pay no income tax on the proceeds (assumes no other taxable income).

Basic State Pension (2013/14)                                  £5,728

Scope for private pension income                            £4,272

Total                                                                               £10,000 per annum plus a tax-free cash sum of £40,685

Based on personal allowance of £10,500, an individual could have a pension fund of £181,790 and pay no income tax on the proceeds (assumes no other taxable income).

Basic State Pension (2013/14)                                   £5,728

Scope for private pension income                            £4,772

Total                                                                                £10,500 per annum plus a tax-free cash sum of £45,447

Non-earning spouses can still contribute up to £3,600 a year into a pension scheme and benefit from tax relief on the contributions. If their pension income falls within their personal allowance, there will be no tax on the income in retirement either.

The firm has also calculated the potential tax savings.

Tax saving

For every £500 the personal allowance increases, basic rate taxpayers save £100 in income tax a year (20%). Higher rate taxpayers are likely to lose the benefit of an increased personal allowance with a reduction or freezing of the higher rate tax threshold.

Those with taxable incomes of £100,000 – £118,880 start to lose their personal allowance on a £1 for every £2 of taxable income basis. ISA income doesn’t count in this calculation. Within these bands the effective tax rate is 60% (ignoring national insurance contributions).

The firm has also highlighted a risk of exclusion for automatic enrolment.

Potential risks of auto-enrolment exclusion

The current earnings threshold for auto-enrolment is set in line with the personal allowance, which means anyone earning in excess of £9,440 is currently eligible for auto-enrolment.

Tom McPhail, Head of Pensions Research says: “One potential risk of increasing the personal allowance, which in itself is a good thing, is that it could exclude many more people from participating in workplace pensions. We estimate that raising the allowance from £9,440 to £12,500 could exclude as many as 3 million people from being automatically enrolled into a workplace pension.”

Of course, those on low earnings could choose to join up.

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