The basic personal allowance is reduced where a person has ‘net adjusted income’ in excess of £100,000. The personal allowance (£10,600 for 2015/16) is reduced by £1 for every £2 by which this limit is exceeded until the allowance is fully abated.
This means that anyone with income of more than £121,200 in 2015/16 loses all their personal allowance.
However, it is possible to preserve entitlement to the personal allowance by reducing income to below £100,000. There are various ways in which this can be achieved, for example by transferring income producing assets to a spouse or civil partner where his or her income is below the £100,000 abatement limit.
Likewise, adjusted net income can be reduced by making pension contributions, which is in itself beneficial due to the higher rate relief that they receive on contributions up to the available annual allowance. Charitable donations would also work (although the donor would lose the benefit of the donation).
John has adjusted net income of £125,000 for 2015/16, of which £30,000 is in the form of interest from investments. His wife has income of £10,000 for the year.
As John has income for 2015/16 in excess of £121,200, he will lose all his personal allowance for that year. By transferring the investments to his wife, his income is reduced to £95,000 and he retains the personal allowance of £10,600.
For a higher rate taxpayer paying tax at 40% the personal allowance is worth £4,240 for 2015/16 (£10,600 @ 40%). By transferring income to his wife John retains the personal allowance. This saves him tax of £12,000 on the savings income (£30,000 @ 40%) and a further £4,240 by reclaiming the personal allowance. His tax bill is therefore reduced by £16,240 (£12,000 + £4,240).
Of the £30,000 savings income transferred to his wife, the first £600 is covered by the remainder of her personal allowance and the next £5,000 is taxed at the savings rate of 0%. The remaining £24,400 (£30,000 - (£600 + £5,000)) is taxed at 20%. His wife pays tax of £4,880 on the savings income (£24,400 @20%).
As a couple they are £11,360 better off. Although his wife pays an additional £4,880 in tax, John saves tax of £16,240 – a combined saving of £11,360.