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Tax

What is Personal Allowance?

The Personal Allowance is the amount of income you can earn each year before paying Income Tax.

Current Rate (2025/26)

£12,570 (frozen until 2028)

Example

First £12,570 of your salary/dividends is tax-free. Only earnings above this are taxed.

Key Dates

Applied automatically through tax code

How Personal Allowance Works in Practice

The Personal Allowance is the amount of income every UK individual can earn in a tax year before any Income Tax becomes payable. For 2025/26, it remains at £12,570 -- a figure that has been frozen since April 2021 and is set to stay at this level until at least April 2028. This freeze is sometimes called a "stealth tax" because inflation means more people are dragged into higher tax bands each year without any headline rate change.

The Personal Allowance applies to all types of income aggregated together -- salary, dividends above the dividend allowance, rental income, pension income, and savings interest above the savings allowance. It is not per source; it is a single allowance covering all your income combined. For most employees, the Personal Allowance is applied automatically through your PAYE tax code (typically 1257L for 2025/26).

Critically, the Personal Allowance is reduced by £1 for every £2 of income above £100,000. This means that once your total income exceeds £100,000, your Personal Allowance starts to shrink. At £125,140, it disappears entirely. This creates an effective marginal tax rate of 60% on income between £100,000 and £125,140 -- you lose both the tax on the income itself (40%) and the tax on the allowance you lose (effectively another 20%). This trap catches many director-shareholders off guard.

For company directors, the Personal Allowance is central to the optimal salary/dividend strategy. Most accountants recommend paying a salary of £12,570 (to use the full Personal Allowance) and taking the remainder as dividends, which are taxed at lower rates than salary. However, the optimal figure depends on whether you have other income sources and whether the Employment Allowance applies.

Step by Step

For employees and directors on payroll, the Personal Allowance is applied automatically through your tax code. The standard tax code 1257L means your employer divides the £12,570 allowance across your pay periods -- roughly £1,047.50 per month tax-free. Any salary above this monthly figure is taxed at the applicable Income Tax rate.

If you have multiple income sources, your total Personal Allowance is typically allocated to your main employment through your tax code. Other income (dividends, rental, self-employment) is declared through Self Assessment, and any unused Personal Allowance is applied there. You cannot claim the Personal Allowance twice.

For income between £100,000 and £125,140, the Personal Allowance tapers. HMRC adjusts your tax code to reflect the reduced allowance, or it is calculated through Self Assessment. Company directors with this income level should consider making pension contributions to bring adjusted net income below £100,000 and restore the full Personal Allowance.

Practical Tips

  • Set your director's salary at exactly £12,570 to use the full Personal Allowance while minimising National Insurance contributions
  • If your total income is near £100,000, consider making pension contributions to keep adjusted net income below £100,000 and retain the full Personal Allowance
  • Check your tax code at the start of each tax year -- an incorrect code means you could be over or underpaying tax all year
  • If your spouse earns less than £12,570, consider the Marriage Allowance transfer to save up to £252 per year

Common Mistakes to Avoid

  • Not realising the Personal Allowance is lost gradually between £100,000 and £125,140 income, creating a 60% effective tax rate
  • Assuming the Personal Allowance applies separately to salary and dividends -- it covers all income combined
  • Paying yourself a salary above £12,570 when dividends would be more tax-efficient (for director-shareholders)
  • Forgetting that the Marriage Allowance lets you transfer up to £1,260 of unused Personal Allowance to a spouse

Frequently Asked Questions

What is the Personal Allowance for 2025/26?

The Personal Allowance for 2025/26 is £12,570. It has been frozen at this level since April 2021 and is expected to remain frozen until at least April 2028.

Do I lose my Personal Allowance if I earn over £100,000?

Yes. The Personal Allowance is reduced by £1 for every £2 of income above £100,000. At £125,140, the allowance is completely eliminated. Making pension contributions can reduce your adjusted net income below £100,000 and restore the allowance.

Can I transfer my Personal Allowance to my spouse?

Partially. The Marriage Allowance lets you transfer up to 10% (£1,260 in 2025/26) of your Personal Allowance to a spouse or civil partner, provided the recipient is a basic rate taxpayer. This can save up to £252 per year in Income Tax.

Does the Personal Allowance apply to dividend income?

Yes, but dividends also have their own £500 dividend allowance. Your Personal Allowance covers all income types in total. If your salary uses up the full £12,570, your dividends start being taxed immediately after the £500 dividend allowance.

What tax code reflects the Personal Allowance?

The standard tax code for 2025/26 is 1257L, which represents a £12,570 tax-free allowance. If your code is different (e.g. BR, D0, or a lower number), it may indicate you have other income, benefits in kind, or unpaid tax being collected through your code.

Source: HMRC Income Tax rates and Personal Allowances: https://www.gov.uk/income-tax-rates

Related Terms

Income Tax

Income Tax is the tax paid on most types of income - salary, dividends, rental income, self-employment profits.

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