The age allowance trap
Pensioners have benefited from a large rise in their tax-free personal allowances. The rise of nearly £1,500 for people aged 65 and over was intended as compensation for the loss of the 10% tax band. People aged 65 to 74 with income up to £21,800 now pay no tax on the first £9,030 of income, and those aged 75 or more pay tax only on income over £9,180.
The age-related part of the personal allowance is reduced by £1 for every £2 of income over £21,800. This rule now results in a band of income between £21,800 and £27,790 being taxed in effect at 30% for a person aged 65 to 74. The extra 10% on top of the 20% basic rate of tax results from the withdrawal of the age allowance. For people aged 75 and over, this 30% band goes up to £28,090.
However, the beginning of a tax year is an ideal time to plan to make sure your income stays below £21,800. If you are married or in a civil partnership, and one of you has income below £21,800, you could transfer income-producing investments from the higher income partner to the other to maximise your combined entitlement to the age allowance.
If that still leaves one of you with income above £21,800, you could consider switching to investments that produce capital gains instead of income. Capital gains are now taxed at 18% and the first £9,600 of gains in the current tax year is free of tax. Ideally you should make the switch soon and before a lot of taxable income has accrued, although you must always consider whether what you plan to buy is a good investment as well as being tax-efficient.
Some investments are tax-free, such as National Savings Certificates, though again you should compare net investment returns. You should certainly use your ISA allowance and there is no need to wait until the end of the year to do this.
If you are under 75 years old, you might even consider paying money into a pension scheme. The payment, grossed up by 20% for basic rate tax, is deducted from your income in the age allowance calculation.