The age allowance trap
March 8th, 2013
From 6 April 2013, the availability of the age-related income tax personal allowance will be restricted. However, with some careful financial planning, many people aged 65 or over before this date can take steps to ensure that they maintain their entitlement in full. This article explores how
What is the age allowance?
Age allowance is an increase in the personal tax-free income allowance which is currently available to any individual in the UK who attains age 65 (or more) during the tax year and whose income does not exceed a certain amount (£25,400 in 2012/13, rising to £26,100 in 2013/14). When income exceeds this threshold, the age-related personal allowance is reduced by £1 for each £2 of additional income – although for individuals with total income below £100,000 the age allowance can never be reduced to less than the normal personal allowance (£8,105 in 2012/13, rising to £9,440 in 2013/14).
So, if someone aged 66 in 2012/13 has total income of £27,400, their age allowance will be cut back by £1,000 (£2,000 / 2) – bringing £1,000 more of their income into charge for income tax.
Older taxpayers, where one party to a marriage or civil partnership was born before 6 April 1935, may also be entitled to married couple’s allowance (MCA) – although like the age-related personal allowance, the MCA is also reduced if income exceeds a certain amount.
What is changing from 6 April 2013?
From 2013/14, anyone born after 5 April 1948 – and who therefore attains age 65 after 5 April 2013 – will only be entitled to the standard personal allowance of £9,440. This means that only those people who had already attained age 65 before 6 April 2013 can continue to benefit from the higher age-related allowance.
Furthermore, whilst the income threshold above which the age allowance is reduced will rise to £26,100, the amount of age allowance will remain frozen at £10,500 for those aged between 65 and 74, and £10,660 for those aged 75 or over.
With the standard personal allowance continuing to increase each year, and the age related allowance having been frozen, it is therefore clear that the age allowance is gradually being phased-out. This doesn’t mean though that those who are currently aged 65 or over and who have income above the threshold, shouldn’t take steps to preserve it for as long as it continues to exist (!)
Preserving age allowance
To preserve these higher income tax allowances, taxpayers may wish to “manage” their income. Particularly helpful are ISAs, because the income is tax-free, and investment bonds may also be of appeal because they allow tax-deferred withdrawals of 5% a year to be taken for 20 years which do not count as ‘income’ either.
It may also frequently be the case that one spouse or civil partner has total income that causes them to lose their own age allowance yet the other has income well below the threshold at which age allowance is cut back. If so, it may be advantageous for the higher earning spouse or civil partner to transfer investments producing taxable savings or dividend income from their own into the other person’s name so that after the transfer both are under the age allowance threshold and therefore able to each benefit from the full age allowance.
Investing for capital growth, rather than income, is also a simple strategy to reduce a taxpayer’s income, and deductions from income for the purpose of testing if the age allowance income threshold has been exceeded are also allowed for the gross amount of any contributions made to a pension or charity.
Making tax-relievable pension contributions is also a perfectly legitimate and extremely tax efficient means of reducing or eliminating what is, in effect, a high marginal rate of tax payable on any income which would otherwise exceed the age allowance income threshold – and even if an individual under 75 does not have any ‘relevant’ UK earnings for pension contribution purposes, they can still benefit from full tax relief on a contribution of £2,880 into a personal pension or stakeholder plan that will then be grossed up to £3,600.
In summary, if you already are or will be 65 before 6 April this year and you are worried that you might be caught in this trap and would like advice on how best to go about escaping it, the good news is that there are a number of valuable tax planning opportunities available that we would be more than happy to discuss with you.