Losing this allowance effectively adds to the individual’s tax burden. When working out taxation of income, you start with the personal allowance, then apply tax at the basic-rate band and then tax at the higher-rate band.

If the personal allowance is removed because the client’s net adjusted income is £114,950 or above, this taxes the client on the £14,950 over £100,000 at an effective rate of 60%. This is because the client now has no personal allowance and so is taxed on the £7,475, which was the personal allowance, at 20% (ie 50% of the higher rate of tax of 40%). In addition to this, as there is no personal allowance, the amount in the higher-rate tax band will be increased by another £7,475, resulting in a 60% tax band rate.

The following illustrates the impact of paying a gross pension contribution of £14,950 for an individual with net adjusted income of £114,950.

Net adjusted income is defined in section 58 of the Income Taxes Act 2007. Broadly it is the total income on which an individual is liable for tax, less the gross amount of any personal pension contributions, or third party contributions. However, remember that this is not the calculation for the actual payment of income tax and National Insurance (NI), and the full income before removal of the pension contribution will be subject to full tax and NI.

If the client has an income in excess of £114,950 and still wishes to make personal pension contributions to reduce their income below the £100,000 threshold, this will still produce an effective tax saving on what would have been paid if this course of action had not been taken. However, as not all of the pension contribution will have the same tax advantages as those within the £14,950 band, the effect of the tax will reduce from the maximum of 60%. The table below gives examples of the effective marginal tax rate a client will pay on various levels of taxable income above £100,000.

The examples below show the effect of the loss of the personal allowance on taxable income over the £100,000 threshold. As is demonstrated, the effective tax on the income over £100,000 can be as high as 60% but does vary with the levels of income involved. An individual with a taxable income of £100,000 will after deduction of the personal allowance be liable for income tax of £30,010.