Six ways to avoid the age-related tax allowance trapOver-65s could face a 30% marginal tax rate
04 June 2012
If you're aged 65 or over, you could be entitled to an extra age-related tax allowance. We explain how to make the most of it.
How do age-related allowances work?
Most UK taxpayers receive a tax-free personal allowance of £8,105 in the 2012/13 tax year. The next £34,370 is taxed at 20%.
If you're 65 or older, though, you could enjoy a higher age-related personal allowance of £10,500. And if you're at least 75 you could receive an income of £10,660 before you start paying tax.
When is age-related allowance withdrawn?
There are earnings limits, above which you'll start to lose your age-related allowances. Age-related allowances are reduced by £1 for every £2 you earn over £25,400. This goes on until your personal allowance falls to the standard level of £8,105.
In practice, this means that the age-related allowance is withdrawn altogether if your income exceeds £30,190 for over-65s or £30,510 for over-75s.
If you earn over £100,000, not only will you lose your age-related allowance, you'll start to lose your standard personal allowance as well, again at the rate of £1 for every extra £2 you earn.
The 30% tax age-related allowance 'trap'
If your income falls between £25,400 (the income at which age-related allowances start to be withdrawn) and £30,190 or £30,510 (the income level at which age-related allowances are fully extinguished), you'll be paying tax at a marginal rate of 30%, far higher than the standard rate of 20%.
This is because you're paying basic rate tax at 20% on the additional income and also losing your extra personal allowance at a rate of £1 for every additional £2 earned, effectively increasing your tax rate by half again. This gives a total effective tax rate of 30%.
How can I avoid losing my age-related allowance?
1. Switch to tax-free savings
If you have money in a standard savings account, consider transferring it into tax-free investments such as cash Isas or, if they're available, NS&I savings certificates.
2. Make donations to charity
Donations to charity under Gift Aid also reduce your 'adjusted net income' used to calculate your personal allowance.
3. Transfer assets to your spouse
If your husband, wife or civil partner is a non-taxpayer or pays basic-rate tax it could be worth transferring income-producing assets such as savings or equities into their name. This could reduce your income to below the level at which your personal allowances start to be withdrawn. This could be particularly valuable if your partner is not eligible for age-related allowances.
4. Reduce your taxable income
This sounds counter-intuitive, but it might be worth reducing your income in a year that you're likely to lose your age-related personal allowances. If, for example, you're self-employed or a director of a company, you might be able to defer income, say by delaying a dividend payment.
This only works if your income next year is either likely to be lower than this year, or if it's likely to be sufficiently higher so that you'll lose your age-related allowances anyway (but without going into the higher-rate 40% tax band).
If you're about to turn 65, it might be worth deferring your state pension, but only if you have enough other income to manage on.
5. Top up your pension
If you've decided to work past state retirement age and haven't started drawing a personal or company pension, making payments into a pension scheme should reduce your 'adjusted net income' which is used to calculate your personal allowance.
6. Switch to capital growth-generating investments
If you hold investments that generate high dividends each year, it might be worth transferring them to capital-growth investments instead. That way you'll reduce your taxable dividend income and should be able to make use of the tax-free £10,600 annual capital gains tax allowance when you cash in your investment.