Living off your Personal Allowance

One of the efficient ways to take an income in retirement is to utilise your PA.  Not your Personal Assistant, but your Personal Allowance.  Each year the government lets the minions of the UK earn some level of income completely tax free, your income could be your wage or a pension for example.

For the 2015/16 tax year in the UK, the individual personal allowance is £10,600 a year, or £883.33 a month.  Sounds pretty measly.

Ignoring the implications of any state benefits (as that is a long way off and looks to be diminishing each year given the financial and demographic state of the UK) and the tax free implications of an ISA, if we took income of £10,600 in Early Retirement we would pay no tax.  Let’s also ignore any moral implications of this for now.

For each £1 above that limit we would start paying income tax, effectively reducing the income by 20% or increasing the capital we need to hold by 25%.  These are pretty chunky percentages, and reducing our exposure would decrease the amount of capital we need to build.

This isn’t to say that you shouldn’t aim for a higher income in Early Retirement or Financial Independence, but you should recognise that the amount of capital required increases by a factor related to the tax that would need to be paid on the income.

With a Withdrawal Rate of somewhere between 4% and 2.5% we would need capital of £265k and £424k to support £10,600 of annual income.

Suspend reality
Let’s assume that I have enough capital, I am confident with my Withdrawal Rate, I declare Financial Independence Day and starting taking an income of £10,600 a year.  Happy days.

But what would living off £10,600 actually be like?  The FIREstarter has an article over here discussing if this would be possible and Huw over at FFB40 is actually living off £10k a year.  It is possible my friends, it is possible.

I thought it would be a good idea to have a look at my current monthly expenditure and see how realistic living off the PA would be, for me, at the moment.

It’s all about me
I’ve gone through our joint account and my ‘discretionary’ spending account to see what I have been spending since the start of December,

The Joint spending is my half of;
– the mortgage
– all household bills
– food
– eating out
– £200 saving

I’ve left the £200 savings in there as it could be used to provide a buffer account or go towards a holiday.  It gives a bit of flexibility.

The discretionary spending account is the cash I give myself each month to spend.  I don’t spend all of it every month, but I’ll include in full here for now.

Spending for the last few months, from just these accounts has been;

So even with a chunky discretionary spend and £200 a month saving, I’m only just over the £883 I was looking for.

I do have an admission.  My mortgage is pretty small, on a great rate and over a very long term.  I figured that I should make more in the long run from savings than I pay on my mortgage, which so far has paid off.  It’s a risk, but hopefully a calculated one.  It would be harder to achieve low numbers with a larger mortgage, but we’d hope to be mortgage free by the time we are actually living off our investments any way.  All it will do is inflate my spending for the moment.

The glaring omissions
I haven’t included any car expenses explicitly in the above.  I don’t see this as a necessity.

Admittedly I run a car and a motorbike at the moment, hardly the most frugal approach. I will take MOT/Taxes/Insurance out of my own discretionary account going forwards.  That hasn’t always happened in the past, I freely admit.  This can be a huge expense though, and removing it completely would be the ideal.  I do less than 2,000 miles a year on the two combined, so I don’t think I would actually miss them too much.

It has also been a cheap few months at the start of the year with no council tax and not many other large one off expenses.

Expense rate
Looking at my running averages since December;

So I’m running at a forward annual expenditure of £11,233 at the moment.  This will not do.

It would seem like a good time for an experiment.  It’s payday next week and the start of a new month of income, saving and expenses.  Let’s see if for April/May/June if I can start to bring my average expenditure down towards £883.33 per month.

It seems doable, let’s see if I can hit these numbers over the next few months and if I haven’t perished from malnutrition I will post an update.  If my numbers are right, this does mean that I am and will be living off less than the minimum wage (£6.50 x 37.5 x 52 = £12,675).  I am such a martyr.

[As an aside.  This article suggests I would be happy in retirement on this amount and this suggests I would be miserable and would need 75% more.  From the same newspaper, although different sources, only 6 months apart.  Another indicator that there is a lot of noise out there? We would do pretty well just figuring things out for ourselves a lot of the time.]

Spend Less, Save More & Escape the Horde

Mr Z

18 thoughts on “Living off your Personal Allowance

  1. Retirement Investing Today

    Hi Mr Z

    I think it's even better than that.

    Firstly, you have your £10,600 allowance as you rightly point out. This would/will be particularly handy for the pension portion of wealth when available as it's treated as income on the way out. So put up to £424k in there and draw down at 2.5% for £0 in tax. Particularly attractive if you're getting 40% tax + NI tax deferral on the way in 🙂

    Next up provided your income (pension draw down idc?) stays equal to or less than Basic Rate of tax all your share dividends outside of ISA/Pension will also not be subject to tax. So again plenty of £0 tax available here.

    Next up let's assume ISA allowances stay at a Real £15,240, you get a Real Return of 4% per annum and you want to draw down at 2.5% you're grabbing another £3,950 or so per annum tax free after only 10 years.

    At this point it's unlikely I'll stay in the UK when I FIRE but if I do I'm planning on my annual tax bill being £0.

    This is my understanding, DYOR and that…

    Cheers
    RIT

    Reply
  2. Dividend Drive

    I am quite lucky in that I am able to live (and not live hyper-frugally) on about £850 a month (so about £10,200 a year).

    In the future when I have a family and various other obligations I don't know how practical that figure would be. I may need to yield and run a car, for instance. But I think it is possible if you have the will. On that front, therefore, I could live within my personal allowance.

    That being said. Most of my investments are in an ISA and so the personal allowance is currently mitigated against. After all, you don't get taxed on the way out of an ISA anyway!

    Interesting article. Thanks for that. Food for thought!

    Reply
  3. Mr Zombie

    Hi RIT,

    Agreed on the pension withdrawal, with 40%+ on the way in and eers contributions it's hard to argue with.

    I'd avoided the tax free lump sum and the ISA allowances for simplicity, but that will provide another boost. 25% lump sum recycled into your ongoing ISA seems like a pretty good option.

    I had completely forgotten about the relief available on share dividends! Perhaps the company share options won't all need to be slowly sold and farmed into my ISA at some point… 🙂

    Italy here we come?

    Thanks for your thoughts!

    Mr Z

    Reply
  4. Mr Zombie

    Hi DD,

    I'm not too far off, and if I remove the £100 of savings then I am there. Also like you, I'm not scraping by and I'm sure I could cut back a lot more.

    Also like yourself, a family down the line will change things, but doesn't make it impossible!

    Mr Z

    Reply
  5. Dividend Drive

    No. You're not far off at all. Cars have the potential to be big drains on your wages (as does travel). At the moment I don't have to travel a great deal which is a blessing. This may, however, change sometime soon! That will know my savings rate for 6.

    However, until recently we were eating out a lot more than usual which was impacting our expenses. This is therefore an easy way to cut back!

    I am happy to say that Miss DD is getting more interested in being more frugal. She came from a much wealthier background than me which does seem to–understandably–influence your attitude to such things.

    However, she is currently in the teeth of a career change with a return to education which has made her more "expenses" aware. I sense that this may well stick for the long-term (I hope) which will make frugal family living a bit more practicable!

    We will see!

    Reply
  6. weenie

    Hi Mr Z
    Great post as it's something that I've been thinking about with regards to saving more in my SIPP or my ISA. Whilst there's immediate tax benefits with saving in the SIPP, I'd like to take advantage of the no tax for ISA withdrawals, so I'd be attempting to just withdraw enough from my SIPP to incur 0% tax and the rest topped up from ISA withdrawals.

    At the moment, if I exclude my savings, I'm living on around £12k a year – quite a bit I could shave off but I'm not yet prepared to do so. I'm not sure that I would be happy living on £10k a year, so I'd be in the miserable camp!

    In my FI projections, I've planned for £20k a year – seemed like a good figure but I should revise my figures as I probably won't need that much, although I intend to do a lot of travelling!

    Reply
  7. Cerridwen

    Thanks for this. Good, clear workings out on how to make life post-work as tax efficient as possible.

    I'm planning to manage my SIPP between 58 and 60/61 so that I can take it all tax free. I've had the boost on the way in and I'm a bit loath to throw it away by paying tax on the way out. After my DB and then my SP kick in I will be paying a little tax, and I don't mind that – after all, schools, hospitals, roads and libraries (if they still exist) do need paying for somehow. 🙂

    As a couple we're aiming for a steady post-tax income of around somewhere between £28,000 – £30,000. I think that's going to be enough to keep us in the manner to which we're accustomed but I am getting a bit twitchy about things like kids needing loans and other unforeseen happenings. We do have an emergency fund and we should be able to keep most of our ISA's pretty much intact and just use the dividends for income so that should help, but when we're not working once it's gone, it will be well and truly gone. Slightly scary.

    Good luck with your experiment and keep us posted.

    Reply
  8. Anonymous

    As I understand it dividend is tax paid if you are on basic rate tax so as long as you are paid dividend and not interest there is no further tax to pay until you get to the higher rate tax band. I reckon you can also separately use your CGT allowance to cash in capital. Your SWR 4% experiment is a case in point. You are using divis and some capital to draw down and I reckon with careful planning there is more than £40k per person available before tax needs to be paid and all this outside what you have in ISA's.

    I sure the tax dudes will have a view – I may be quite wrong but I happy to learn!

    I'm enjoying watching your 4%SWR articles!

    Cheers, Timbo

    Reply
  9. Mr Zombie

    Hello,

    It's a tough balance that's for sure. I have missed of some expenses from the £11.2k (our wedding expenses being the main) so it's not 100% all I've spent, but I'm going to try and hit these numbers this spring/summer.

    I think I thought about £25k a year initially, like you say it could be reduced. And travel will be done for sure!

    Mr Z

    Reply
  10. Mr Zombie

    Hi Cerridwen,

    It would be good if you could filter your tax someway, force it to be spent on certain areas.

    That sounds like a nice amount :). I have no idea how we deal with one-off expenditures once we cease to take a wage, and lending to children is a touchy subject I imagine. But I do know that we are planning away and more likely to be in a better position than most to deal with them.

    Thanks, and will do.

    Mr Z

    Reply
  11. Mr Zombie

    Hi TImbo,

    Thanks for the comment. Up to £40k each per annum in retirement would be outstanding. I think you are right on the CGT element, from my understanding (I'm no tax accountant though!).

    Thanks :). I have completely ignored taxes and fees for the moment as it does all get complicated, but at the end of the year I do plan to go back and calculate how much they would have cost. Could be painful!

    Mr Z

    Reply
  12. Anonymous

    One thing to consider is that since the PA is £10,600 per person, then living with your spouse you have an effective £21,200 to work with. £10,600 by yourself might be a bit hard, but still even doable, but having £20k+ tax free (ignoring all other tax free benefits) between 2 people doesn't seem too bad at all. Economies of scale and all that

    Reply
  13. Mr Zombie

    Hi,

    Yeah, definitely. It's a place to start from and then can always add on what other expenses are necessary. It seems a good experiment as it's easy to stick your head in the sand and assume you'll be fine living of £Xk a year when that might be nothing or far too much…

    Mr Z

    Reply
  14. Anonymous

    Timbo is correct on the annual exemption. The CGT annual exemption is £11,100 for 2015/16 so any capital gains (e.g. from share sales) below £11,100 would be tax free. The personal allowance only applies to income, not gains.

    On the dividend point, dividends come with a 'notional' 10% tax credit (to account for corporation tax paid by the company on its profits). It is not refundable though as it is essentially a pretend credit.

    Now, dividends are also taxed at 10% if your earnings are within the basic rate band so no tax to pay as it would be covered by the notional credit. Taking everything together, if your income came only from dividends and some capital gains you could get £42,385 income and £11,100 gains tax free for a total of £53,485 – probably more than enough to survive on 🙂

    Great blog by the way, keep it up!

    A tax accountant making the first steps towards FI.

    Reply
  15. theFIREstarter.co.uk

    Hi Mr Z,

    Not sure how I missed this one, great article and thanks for linking to one of my posts within!

    How did the experiment go!?

    I came back to this one as had a ping back from a spam website that is ripping off your post btw… not sure if there is anything you can do about it!? The site is here: http://financesolutions.science/living-off-your-personal-allowance/ (Please remove the link or even this whole last paragraph so it doesn't get any link juice!)

    Cheers!

    Reply

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