Over 30 million UK adults currently pay income tax. While the amount of income tax you pay per month is fairly clear on your payslip and/or on the HMRC website, the way it’s calculated isn’t so obvious.
In fact, in 2019, Deloitte completed a survey on over 2,000 UK adults to gauge their understanding of current tax rules. This survey revealed that, on average, respondents were only able to answer a third of questions correctly. This significantly differed by age, with 18–24-year-olds performing the weakest (6.9 correct on average, while over 55s answering the most questions (12.3 correct on average; still low!).
NOTE: I’m only going to cover income tax rules for England and Northern Ireland. Wales and Scotland can have slightly different rates.
You can find information for all regions here.
What is Income Tax?
Put simply, income tax is a very broad tax that is paid on your income. This applies to most, but not all types of income. You are obligated to pay this tax regardless of how your paid, whether it be in cash or via bank transfer.
If you are employed by a company (i.e., are PAYE), then this tax is usually calculated and deducted for you before you are paid. But sometimes, companies make mistakes! Therefore, it’s important to know how to calculate this tax yourself, just in case. If you’re self-employed, you’ll need to calculate how much tax you pay yourself.
Here are a few examples of income that may be subject to Income Tax:
- Employment income above the Personal Allowance
- Employment benefits included with your job
- Profits you make if you are self-employed
- Some state benefits, e.g., Jobseekers Allowance
- Most pensions (including the State Pension)
- Rental income above the Property Allowance
- Interest on savings not in an ISA
- Trust income
Are There Any Exemptions?
As with all things in the UK, it isn’t as simple as having a flat rate of tax for all income. So, let’s take a look at some of the exceptions. Thankfully, these usually benefit you, the taxpayer, so it’s worth knowing about them!
Here are some examples of exceptions to Income Tax:
- Employment income below your Personal Allowance
- Rental income if you live in the same property and do not earn more than £7,500 per year in rental income. This is known as the ‘Rent-a-Room’ Allowance
- Dividend Income below the £2,000 per year Dividend Allowance
- Premium Bond wins. Premium Bonds are held in a tax-free account
- National Lottery wins. These winnings are considered ‘gambling’ wins by HMRC, so are not subject to tax
- Income earned from tax-exempt accounts, such as an ISA (Lifetime ISA, Stocks & Shares ISA, Cash ISA, etc). This includes any dividends or capital gains, regardless of how much money is made
- Pension lump sum. In most cases, up 25% of the total value of your pension can be withdrawn tax free at a certain age
How Much Do I Pay?
There are three Income Tax ‘bands’, which define how much tax you will pay based on the amount of total income you earn.
For the 2023-2024 tax year, the Income Tax bands are:
| Tax Band | Income | Tax Rate |
|---|---|---|
| Personal Allowance* | £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £125,140 | 40% |
| Additional rate | Over £125,140 | 45% |
To read more on the Personal Allowance, click here.
MISCONCEPTION: Many people believe that they pay the same rate (e.g., 40%) on all of their income. This is not true at all. You do not pay this percentage on all your income, only the amount within each individual tax band! See the example below to see what I mean.
Example
Let’s say you earn £70,000 per year (not a bad salary… Where can I sign up?). We’ll also assume you have no other income/jobs, so you have the standard Personal Allowance.
First, we must work out which tax band you lie in, and the amount of tax due within each band, separately.
In this case, you earn over £50,270, but below £125,140, meaning you’re in the Higher Rate (40%) band.
Therefore, you’ll expect to pay the following tax:
- First £12,570 – 0% tax, resulting in £0 Income Tax due
- This is your tax-free Personal Allowance
- Between £12,570 and £50,270 – 20% tax, resulting in £7,540 Income Tax due
- £50,270 minus £12,570 equals £37,770
- Multiplying £37,770 by 20% (or 0.2 on a calculator) equals £7,540
- Between £50,270 and £70,000 – 40% tax, resulting in £7,892 Income Tax due
- £70,000 minus £50,270 equals £19,730
- Multiplying £19,730 by 40% (or 0.4 on a calculator) equals £7,892
Now, we simply add these figures up. In total, you would pay £15,432 (£7,540 plus £7,892) in Income Tax for the year.
Here’s a visual illustration of what this looks like:
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