Taxpayers brace for a financial hit after personal allowance rule change

British taxpayers are bracing for a fresh financial hit as changes to the personal allowance creeps closer.

While the personal allowance itself is not changing, remaining frozen at £12,570 until 2031, a subtle change will take effect from the next tax year, as the government places a new lock onto how it is applied, affecting investors and landlords.

From April 2027, the personal allowance will be required to apply first to income from employment, self-employment and pensions, and only once this is accounted for will any remaining allowance be used on property income, savings interest and dividends.

Under the current system, HMRC rules state that the personal allowance must be allocated in a way that is the most tax-beneficial for the taxpayer, with no tax on income below the £12,570.

This typically means deducting the personal allowance from earned income first, but for those who have savings and dividend income, the allowance is sometimes set against the other income streams.

The rule change means the government will be able to push more of taxpayers’ income into higher bands through dividends, property income and savings.

The sting itself

While the sting for taxpayers does not lie within the rule change itself, it will interact with higher tax rates, which are also being introduced.

For basic rate taxpayers, the rate for property and savings will jump two percentage points to 22 per cent from 20 per cent.

Higher rate taxpayers will be subjected to a rise from 40 to 42 per cent, while additional rate taxpayers will rise from 45 per cent to 47 per cent.

Meanwhile, a two percentage point increase has already been inflicted on both basic rate taxpayers and higher rate taxpayers on dividend income.

Basic rate taxpayers will now be charged 10.75 per cent up from 8.75 per cent.

Higher rate tax payers, who earn between £50,271 and £125,140 will be slapped with a 37.75 per cent charge up from 35.75 per cent.

Additional rate taxpayers will continue to shoulder a 39.35 per cent rate.

This means when personal allowance is locked to cover employment or pension income first, income taxed at the typical rates will push more rental or investment income into higher bands.

Calculations

Under the 2027 rules, a worker on an income of £30,000 who has £15,000 property income alongside £6,000 in savings and £2,000 in dividends, would see their personal allowance be deducted only from earned income.

This would subject them to a tax hike of roughly £676 per year, with £236 of it a result of the personal allowance restrictions.

2027 changes

The changes to personal allowance is not the only change taxpayers will be subjected to from the 2027/28 tax year, including a shakeup to estate planning.

Residual pension funds left at death will be liable to IHT, as well as lump sums from defined benefit pensions.

This means the funds will form part of a person’s estate and be subject to IHT up to 40 per cent, depending on other assets and the use of nil rate band.

Once IHT has been paid, any withdrawals from pensions will be liable to income tax at the beneficiary’s marginal rate if the person who passed was aged 75 or over.

The cash ISA ceiling will also be slashed from £20,000 to £12,000 for under 65s, but stocks and shares ISAs will maintain the £20,000 ceiling.