Personal tax allowances: a guide

We all want our finances to be efficient. Just like you might pay into a pension for the basic-rate tax top-up or contribute to an ISA for the tax-relief on income or growth, there are other tax allowances that can benefit unwrapped investments. Here, we look at some of the other allowances available to individuals so that you can be sure you’re making the most of them where you can.

Personal Savings Allowance

The personal savings allowance is used to offset tax on interest income. The amount varies depending on your marginal rate of tax and is a ‘use it or lost it’ allowance; it cannot be carried forward to the next financial year.

For the last few years, this allowance hasn’t been very interesting for many individuals given the low interest rate environment. We’ve all been receiving near-zero (if not actually zero!) interest rates on savings and deposits and so interest income has been negligible for most. More recently, however, we’ve seen central banks raising rates in order to combat rising inflation and for the first time since the Global Financial Crisis in 2008, many savers are starting to receive interest income again.

The Personal Savings Allowance doesn’t just apply to cash in the bank, either. It applies to any interest income received, so can also be applied to income from government or corporate bonds as well as some funds, investment trusts or ETFs depending on their underlying investments. Your tax statements from the fund platforms you use should separate interest and dividend income for the purpose of reporting.

The Personal Savings Allowance (as at 2022/23) is up to £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers do not have a Personal Savings Allowance (i.e. their allowance is £0). Any interest income received in excess of the Personal Savings Allowance is subject to income tax at your marginal rate.

Dividend allowance

The dividend allowance is available to all UK taxpayers. In 2022/23, the allowance is set at £2,000 per year.

The allowance is beneficial to investors who hold assets outside of an ISA or a pension - as any dividends received within these wrappers are already tax-exempt - and applies to the first £2,000 of dividend income that you receive.

In practice, this covers the total dividend income for many personal investors; if you assume that a fund has a 2% income yield, you would need to have over £100,000 invested in that fund before your income breaches the annual allowance.

Any dividend income received in excess of the allowances is taxed at your marginal rate for income tax. Remember that the tax rates for dividends are different from the tax rates on earned income (dividend tax rates are lower).

As with the Personal Savings Allowance mentioned above, the Dividend Allowance cannot be carried forwards; if you don’t use the full allowance in the financial year, you will lose it. You’ll then start the new financial year in April with a brand new dividend allowance.

Capital Gains Tax exemption

Capital Gains Tax is paid on profits made when disposing of an asset. If, during the year you sell an investment for £15,000 for which you paid £10,000, you have realised a gain of £5,000 which is liable to tax.

This is where the Capital Gains Tax exemption comes in; each year every individual has an exemption. Currently, this is £12,300 per person. The first £12,300 of realised gains are exempt from Capital Gains Tax. Any gains realised beyond this allowance are liable for Capital Gains Tax. As with dividends, the rates of capital gains tax are different to ordinary income tax rates.

There are some assets on which you don’t pay capital gains tax; your main residence or directly held UK government gilts are exempt. You also do not pay capital gains tax on gifts to a spouse, civil partner or a charity. You would, however, need to pay capital gains tax if you gift an asset to an individual who is not your spouse or civil partner, for example a child or grandchild.

As with other allowances, you cannot carry forward the exemption if you don’t use it in the financial year. You can, however, carry forward losses. If you sell an asset for a loss, the loss will be used to offset your gains made in the same financial year. If your overall gain for the year is actually a loss (i.e. you’ve lost more than you’ve gained), you can carry forward those losses. This might not seem to matter much at the time, but you may have a large gain in the future which is not covered by the annual exemption; in that instance you can use your carried forward losses to reduce the tax bill.

Currently, capital gains that fall within the basic rate band of income tax are taxed at 10% (or 18% for gains from property) whilst gains that fall within the higher- or additional-rate income tax brackets are taxed at 20% (or 28% for property).

Which tax allowances should I aim for?

There is, unfortunately, no clear-cut answer to this question. Industry consensus remains that first and foremost you should try to make the most of your ISA allowance where you can, given that interest, dividends and capital gains are all tax exempt within an ISA wrapper. Beyond this, it really depends on what type of assets you are buying and how you spread your wealth between cash, investments and so on.

UK investors have a whole host of tax allowances available to them in order to reduce the tax burden on their wealth and their investments. Knowing what these allowances are, what they apply to and how they work is key to ensuring that your finances are as efficient as possible from a tax perspective.

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Date of publication: 11th November 2022