Avoid 40% and what to do if that's not feasible

horsewithnoname

Terrible problem to have. You could give away a load of money; job done

Jeremy535897

See https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/saim1090

Sarahspangles

D&C has given a very clear answer on the tax treatment. That would be challenging even for HMRC gurus.

I’m probably pointing out the obvious, but if she’s that close to paying higher rate tax is there scope to swerve that for longer by commuting some pension for a lump sum, or taking stepped payments to State Pension age. The commutation factor may not be a good one, and it leaves you with a lump sum that may incur tax on interest until you can get it into tax shelters, but it’s worth doing the sums. 

TMSG

TMSG said:

But what when the numbers change? Say a few years later her pensions are at £33k, the savings at £14k and the dividends at £11k, still with current allowances in place. My understanding is that she can allocate her PA as she sees fit (though not the rest of her income).
Would it be wise then to allocate her PA first to the £11k dividends and the rest to the other income? Probably not as 8.75% is less than 20% and 33.75 is less than 40%. OTOH, if we allocate all her PA to the non-dividend income, then she'll have to pay at least for some of the dividends 33.75% instead of 8.75%. I am not clear what the best allocation strategy is in this case so I've done two quick'n'dirty calculations with non-dividend income as pensions £33k + interest £14k=£47k and dividend income as £11k:
Case 1, the PA goes fully to Non-dividend income: (47,000-12,570-500)*20%=6786. She's left a basic rate allowance of 50,270-47,000=3,270 for the first part of the dividend income so 3,270*8.75%=286. She's left dividend income of (11,000-3,270-500)*33.75%=2,440. Total=6,786+286+2,440=9,512.
Case 2, the PA goes first to dividend income: (11,000-500)*8.75%=918. She's left a PA of 2,070 plus 500 Savings Allowance so she pays tax on 46,500-2,070=44,430 or 37,700*20% + (44,430-37,700)*40%=10,232. Total=11,150.
So it appears that case 1 is better for her. Does that make sense? If so, will the HMRC SA calculation pages do the case 1 calculation as a matter of course or do we have to do something? All input welcome!

@Dazed_and_C0nfused Yeah, I brainfarted pretty badly: my mathematical mojo went up in virtual smoke somewhere between Case 1 and 2
So I'll try again:
Case 2, £10,500 PA+£500 Dividend Allowance goes to the dividend income so she's left a PA of 2,070 plus 500 Savings Allowance so she pays tax on 47,000-2,070-500=44,430 or 37,700*20% + (44,430-37,700)*40%=10,232.
If this is now correct Case 1 is still better?!

@Jeremy535897 I'd already read that page before but I think this is where some of the confusion surrounding this comes from. If I am not completely mistaken, the page you mentioned explains the order once the PA has been consumed and I agree that in this case the order is clear, as described, and can't be changed. However, my understanding is that the tax payer can freely allocate their PA (of £12,570) in whatever way is the most beneficial. At least there a dozens of pages which say so!?

saajan_12

TMSG said:

TMSG said:

But what when the numbers change? Say a few years later her pensions are at £33k, the savings at £14k and the dividends at £11k, still with current allowances in place. My understanding is that she can allocate her PA as she sees fit (though not the rest of her income).
Would it be wise then to allocate her PA first to the £11k dividends and the rest to the other income? Probably not as 8.75% is less than 20% and 33.75 is less than 40%. OTOH, if we allocate all her PA to the non-dividend income, then she'll have to pay at least for some of the dividends 33.75% instead of 8.75%. I am not clear what the best allocation strategy is in this case so I've done two quick'n'dirty calculations with non-dividend income as pensions £33k + interest £14k=£47k and dividend income as £11k:
Case 1, the PA goes fully to Non-dividend income: (47,000-12,570-500)*20%=6786. She's left a basic rate allowance of 50,270-47,000=3,270 for the first part of the dividend income so 3,270*8.75%=286. She's left dividend income of (11,000-3,270-500)*33.75%=2,440. Total=6,786+286+2,440=9,512.
Case 2, the PA goes first to dividend income: (11,000-500)*8.75%=918. She's left a PA of 2,070 plus 500 Savings Allowance so she pays tax on 46,500-2,070=44,430 or 37,700*20% + (44,430-37,700)*40%=10,232. Total=11,150.
So it appears that case 1 is better for her. Does that make sense? If so, will the HMRC SA calculation pages do the case 1 calculation as a matter of course or do we have to do something? All input welcome!

@Dazed_and_C0nfused Yeah, I brainfarted pretty badly: my mathematical mojo went up in virtual smoke somewhere between Case 1 and 2
So I'll try again:
Case 2, £10,500 PA+£500 Dividend Allowance goes to the dividend income so she's left a PA of 2,070 plus 500 Savings Allowance so she pays tax on 47,000-2,070-500=44,430 or 37,700*20% + (44,430-37,700)*40%=10,232.
If this is now correct Case 1 is still better?!

@Jeremy535897 I'd already read that page before but I think this is where some of the confusion surrounding this comes from. If I am not completely mistaken, the page you mentioned explains the order once the PA has been consumed and I agree that in this case the order is clear, as described, and can't be changed. However, my understanding is that the tax payer can freely allocate their PA (of £12,570) in whatever way is the most beneficial. At least there a dozens of pages which say so!?

I always thought there's a set order, and the tax payer can't choose which bits of income to apply to each tax band. However if that's not the case (not sure) then mathematically you want to allocate 
* £500 savings allowance + £500 dividend allowance to the respective moneys
* £12570 personal allowance to pension / savings (as the 20/40% tax rates are the highest there)
* maximise basic rate band for the dividend income, as 8.75% is the lowest and the jump up to higher rate is the highest (8.75% -> 33.75%)
* any higher rate tax payable ideally on the pension or savings income (reason is once you've exhaused the allowances, then you'll pay at least 20% there.. the jump to higher rate is only another 20%)

That means 
* £10500 dividend income in basic rate band @ 8.75%
* £27200 of pension and savings income to basic rate band @ 20%
* £6730 of pension and savings income to higher rate band @ 40% 
Total £9050.75

That's less than your case 1 by my calculations, BUT I'm not sure if you're allowed to divide it like that. 

TMSG

@saajan_12 Confusion reigns. The link @Jeremy535897 provided above makes it clear that there is a specific order in which income has to be allocated. However, as far as I understand it, this order is not compulsory for the PA part of the income... the taxpayer can allocate their income as is most beneficial for them.
See for instance https://www.litrg.org.uk/tax-nic/income-tax/tax-allowances/personal-allowance and there are many, many others who say the same thing and even give various examples. Apparently even HMRC staff do not always know that the income allocation for the PA only can be flexible.
Other than that I agree with your analysis!

Dazed_and_C0nfused

That means 

Total £9050.75
* £10500 dividend income in basic rate band @ 8.75%
* £27200 of pension and savings income to basic rate band @ 20%
* £6730 of pension and savings income to higher rate band @ 40% 

That simply isn't possible.  You can allocate the Personal Allowance in whichever way gives the smallest liability.

But once that has been done the remaining income, which is what the bit copied above is dealing with, has to be taxed in a specific order.

You cannot tax dividends income first.

saajan_12

Dazed_and_C0nfused said:

That means 

Total £9050.75
* £10500 dividend income in basic rate band @ 8.75%
* £27200 of pension and savings income to basic rate band @ 20%
* £6730 of pension and savings income to higher rate band @ 40% 

That simply isn't possible.  You can allocate the Personal Allowance in whichever way gives the smallest liability.

But once that has been done the remaining income, which is what the bit copied above is dealing with, has to be taxed in a specific order.

You cannot tax dividends income first.

Fair enough. You're quoting me, and I did say I didn't think you could choose the order, but if you could that's how to minimise. 

If its just a question of choosing what is covered by the PA and what isn't, then the first part of my post covers it.. you want to pick the part that has the highest rates, which in this case is pension & savings (20% / 40%). Afaik that's the highest rates so surely the tax payer would always be better off allocating PA to pension / savings interest first, followed by dividends. 

Wouldn't even be a need to select.. 

Dazed_and_C0nfused

saajan_12 said:

Dazed_and_C0nfused said:

That means 

Total £9050.75
* £10500 dividend income in basic rate band @ 8.75%
* £27200 of pension and savings income to basic rate band @ 20%
* £6730 of pension and savings income to higher rate band @ 40% 

That simply isn't possible.  You can allocate the Personal Allowance in whichever way gives the smallest liability.

But once that has been done the remaining income, which is what the bit copied above is dealing with, has to be taxed in a specific order.

You cannot tax dividends income first.

Fair enough. You're quoting me, and I did say I didn't think you could choose the order, but if you could that's how to minimise. 

If its just a question of choosing what is covered by the PA and what isn't, then the first part of my post covers it.. you want to pick the part that has the highest rates, which in this case is pension & savings (20% / 40%). Afaik that's the highest rates so surely the tax payer would always be better off allocating PA to pension / savings interest first, followed by dividends. 

Wouldn't even be a need to select.. 

I understand your logic but I'm not 100% sure it is quite that straightforward.

Making the optimum use of the three different 0% rate bands is key.  But they all sit within the basic or higher rate band, adding further complexity!

TMSG

Dazed_and_C0nfused said:

I understand your logic but I'm not 100% sure it is quite that straightforward.
Making the optimum use of the three different 0% rate bands is key.  But they all sit within the basic or higher rate band, adding further complexity!

 After what I've read about the interplay between these factors there seem to be some cases where the optimal allocation for the PA element is not the "obvious" one. The vast majority though appears to be pretty straightforward along what @saajan_12 has outlined.

Anyway, my original Q is answered

Thanks all for the input, esp Dazed_and_C0nfused!