Tax Code/Tax-free Allowance Reduction despite low earnings

binkbumb

Every year my tax code (and therefore tax-free allowance) is reduced by the amount of ANY interest I earn (or HMRC estimates I'll earn) despite the fact I earn nowhere near the threshold (which, for me is £18,500 in theory).  The explanation from HMRC confuses me - it's usually - 'That's what the system does' or thereabouts. I have put an excerpt below.  Could someone please help and explain to me why this happens?  I have asked HMRC several times and never get a straight or logical response!

***live chat***

HMRC: Thanks, can you confirm your estimated salary for this employer? ME:  £10,333.00 

HMRC: can you tell me what the problem with the tax code is? 

ME: the tax code has been changed, it  should be 1125N - why has £648 interest been deducted from my tax-free allowance and code changed to 1061N?

HMRC: 12,500 -1,250 (marriage allowance transferred) =11,250 then minus 638 interest - this is only taken off because you are earning below the tax free allowance if you earned more it would not be in your code, you can earn up to 1,000 in interest/savings before you pay tax, it does not charge you anything.  it will not come out of the tax code unless you earn more as it does not effect your tax free amount

ME: My tax free amount is below £18,500 so why is anything done to change my tax code?

HMRC: the thresshold is 12,500 unless you have deductions like you have the marriage allowance if you was going to earn 11,250 then the interest would not

show, it does not effect you tax free allowance.  it is not a problem this has always been the case, i can not speak for another adviser but i can tell you i know exactly what i am doing here and there is no impact on your code

ME: My code is 1061N! It needs to be 1125N. My tax free allowance is also incorrect

HMRC: i can take your interest out if you really want and wait for the bank to re update us but it is definitely not effecting your pay

ME: I'm not talking about my pay, my tax code is wrong, HMRC should not be including interest below £1000. So the £638 is a made - up figure?

HMRC: they can include the figures yes however they can not charge you for it correct however it is not charging you, if you earned more your code would go

higher

ME: The £638 must be an estimate so please remove it entirely

HMRC: i have reduced them to 0.00 as requested and the code is now 1125N

molerat

It is what they do.  If you have spare allowance above your estimated income they will allocate savings interest to fill the gap, personally I don't understand why but they do.  If you are not going to earn anywhere near the new adjusted allowance then there is no point getting it changed.  The alteration does not affect your personal allowance, it is still £11250, the tax code is purely a way of trying to collect the correct amount of tax taking into account other factors.

eskbanker

This partly comes down to the common misunderstanding that the personal savings 'allowance' is literally a tax-free allowance, but it isn't - that (up to) £1,000 of savings is taxable income but is taxed at 0%, a subtle distinction that is lost on many.

You also seem to be under the impression that a lower tax code means that you'll pay more tax but it doesn't mean that at all - the tax code is simply used as a mechanism to assist employers with PAYE deductions but doesn't actually dictate how much tax you pay over the year, which is a separate calculation.  Where your earned income is below the personal tax allowance (£12,500 plus/minus adjustments like marriage allowance but not savings/dividend 'allowances'), it won't affect your tax in the way you suspect it does - there's nothing stopping you from asking HMRC to adjust the code to ignore the projected savings interest income, but don't be under the impression that doing so affects how much tax you pay or serves any useful purpose....

binkbumb

It's lost on many because HMRC can't even explain it or put it in any of their literature.  Many thanks for the explanation.

Dazed_and_C0nfused

The bottom line is that neither of the 0% tax rates which make up the £6,000 which can be taxed at 0% are applicable to you.

Your expected taxable income is less than your Personal Allowance which means that your interest is covered by your spare Personal Allowance.

Based on what you originally posted the code of 1061N was correct.

Winter66

seen your show to night and you talked about your tax free allowance, what you did not say is that the £12500 is reduced for every £1000 you earn over £100,000.

eskbanker

Winter66 said:

seen your show to night and you talked about your tax free allowance, what you did not say is that the £12500 is reduced for every £1000 you earn over £100,000.

I presume you're under the illusion that your comment will be read by Martin Lewis, but the reduction in personal tax allowance is hardly a secret (https://www.gov.uk/income-tax-rates/income-over-100000), and in a highly summarised overview, Lewis can be forgiven for focusing on the 98.5% not in that band rather than the 1.5% who are (and who probably won't be perceived as needing to know that if they don't already)!

Edit: this is also spelt out on this site at https://www.moneysavingexpert.com/banking/tax-rates/#pa

ColdIron

Winter66 said:

seen your show to night and you talked about your tax free allowance, what you did not say is that the £12500 is reduced for every £1000 you earn over £100,000.

The show was aimed at young people, few of whom earn in excess of £100,000