Income Tax
The English income tax system is split into multiple bands. For the sake of clarity, all income will be given per annum. The first band called the Personal Allowance is not taxed and so any money made up to the limit is not taxed. The standard limit is £12,570 but this limit is variable. Any money made after the first band is taxed in the second band called Basic Rate at 20% up to £50,270. The third band is called Higher Rate and is from £50,271 to £125,140 and is taxed at 40%. Between the third and fourth band there is an additional tax increase. For every £2 over £100,000, £1 is removed from the Personal Allowance, hence why the limit of Higher Rate is £125,140. The standard Personal Allowance is £12,570, double that is £25,140 then add £100,000 totals £125,140. This effectively means that any money received over £100,000 and before £125,140 is first taxed at 20% rate and then again at 40% rate. The fourth band is called Additional Rate and is for anything >£125,140 and this is taxed at 45%. The limits for Higher and Additional bands can be pushed up due to the Basic Rate band increasing. For the sake of clarity, Personal Allowance will be shown at the standard rate from here on out. A table of the rates can be found below:
£0 - £12,570 : 0%
£12,571 - £50,270 : 20%
£50,271 - £125,140 : 40%
£125,140 - ad infinitum : 45%
Tax Codes
The English income tax system uses a code to decide how much is received in the Personal Allowance. The tax code is made up of multiple numbers and a letter. The number is the total amount of Personal Allowance minus trailing 0s. The letters are a code that explain the difference in Personal Allowance. Below is the list of letters with explanations:
L - You’re entitled to the standard tax-free Personal Allowance
M - Marriage Allowance: you’ve received a transfer of 10% of your partner’s Personal Allowance
N - Marriage Allowance: you’ve transferred 10% of your Personal Allowance to your partner
T - Your tax code includes other calculations to work out your Personal Allowance
0T - Your Personal Allowance has been used up, or you’ve started a new job and your employer does not have the details they need to give you a tax code
BR - All your income from this job or pension is taxed at the basic rate (usually used if you’ve got more than one job or pension)
D0 - All your income from this job or pension is taxed at the higher rate (usually used if you’ve got more than one job or pension)
D1 - All your income from this job or pension is taxed at the additional rate (usually used if you’ve got more than one job or pension)
NT - You’re not paying any tax on this income
W1, M1, X - Are Emergency tax codes
K - Only at the front of a code and means you have income that is not being taxed any other way and is worth more than your Personal Allowance
The standard tax code is 1257L where the 1257 is the £12,570 of Personal Allowance and the L signifies the standard rate.
Personal Allowance
Personal Allowance can be altered in a number of different ways with the standard rate being £12,570. The primary cause for the rate being reduced is Taxable Benefits. If a person receives a benefit while working at a company and this benefit is deemed at taxable then the person will pay the tax on the cost of that benefit. A common benefit is Private Medical Care and will be used as an example to show how this affects a person's Personal Allowance. If a company pays £600 a year for a person's private healthcare then £600 will be removed from that person's Personal Allowance bringing it down to £11,970. This means they will pay 20% at the Basic Rate on the £600 over the year, equalling £120 additionally deducted. If a person's Personal Allowance has been used up then the basic Rate band will increase by the value of all deductions that would normally be applied to that person's Personal Allowance. This would not change the previous example as the same amount of money is deducted overall and is not included in the calculation to remove Personal Allowance for income > £100,000. Personal Allowance's can be increased using Government schemes such as the Bike to Work Scheme. This is calculated by taking a % of the value of the bike and adding it the Personal Allowance making the value of the item effectively that % cheaper as no tax is paid on it. These schemes usually run over multiple years so calculating it with an income is unnecessary and tedious.
Marriage Allowance
Marriage Allowance is for a married couple where one receives less than their personal allowance income. Up to £1,260 of the individual's Personal Allowance may be transferred to their partner's Personal Allowance. Marriage Allowance is applicable only if the partner who is using their entire Personal Allowance is receiving an income less than £50,270. Here is a worked example: "Your income is £11,500 and your Personal Allowance is £12,570, so you do not pay tax. Your partner’s income is £20,000 and their Personal Allowance is £12,570, so they pay tax on £7,430 (their ‘taxable income’). This means as a couple you are paying Income Tax on £7,430. When you claim Marriage Allowance you transfer £1,260 of your Personal Allowance to your partner. Your Personal Allowance becomes £11,310 and your partner gets a ‘tax credit’ on £1,260 of their taxable income. This means you will now pay tax on £190, but your partner will only pay tax on £6,170. As a couple you benefit, as you are only paying Income Tax on £6,360 rather than £7,430, which saves you £214 in tax."
National Insurance (updated to for 6 January 2024 to 5 April 2024)
In addition to the income tax system, there is National Insurance contributions (NI). This is a tax used to pay for the NHS among other things. This money is deducted at the same point as income tax. It is split into two bands with the first band coming into effect at £12,576 (effectively equivalent to standard rate Personal Allowance) up to £50,268 (effectively the limit of Basic Rate) at 10%. Anything >£50,268 is paid at 2% rate. A table of the rates is below:
£0 - £12,576 : 0%
£12,576 - £50,268 : 10%
£50,268 - ad infinitum : 2%
With the two tax systems Income Tax and NI coming at the same point they can be calculated additionally and made into a single table to understand the total taxable rates:
£0 - £12,570 : 20%
£12,571 - £50,270 : 30%
£50,270 - £100,000 : 40%
£100,000 - £125,140 : 60% (removed Personal Allowance)
£125,140 - ad infinitum : 45%
It is important to note that Income Tax and NI are deducted separately as the rate bands are not exactly the same, NI actually varies on whether it is paid per month or week and Personal Allowance varies. Therefore, even though they are both taken at the same point, calculating expected deductions should be done separately and not by adding the two.
PAYE
If a person has an employer then it is most likely that they use the Pay As You Earn (PAYE) system. This is a system that relies on the employer to deduct the correct amount of income tax and NI from an employee's salary. This reduces the likelihood of incorrect deductions and payments. There can still be manual payments required if the tax code is incorrect or there are a large amount of income from other sources. Person's with these sorts of incomes are often required to fill out Self Assessment forms. In these forms any money coming from over sees, or Capital Gains or private businesses are declared so that the government can issue a more accurate tax code allowing an employer to make the correct deductions.
Pensions
When a pension is taken out it is taxed in the same manor as any other form of income with the exception of paying no National Insurance. 25% can be taken from the pension pot tax free as well. The primary use for pension payments in terms of taxes is that all payments into your pension are made before tax meaning that it can be a useful tool to save money. If a person has a large amount of disposable income and are paying a large amount of tax on it then they may choose to pay some of this money into their pension as it will reduce their taxes overall.
Student Loan Repayment
Any student who took out a Student Load to study an undergraduate course between 1st September 2012 and 31st July 2023 will repay this debt under Plan 2. The threshold for Plan 2 is £27,295, any income above this has a 9% deduction. Therefore a person that makes £30,000 a year will be charged on £2,705 of that. At 9% deduction rate this will equate to £20 deductions per month. Interest is applied to this loan every month from the first payment and until it is paid off. The interest is calculated and set on 1st September of each year. It is based on the Retail Price Index (RPI) of the previous March plus up to 3% depending on circumstances and income. A cap can be applied to ensure the charge is not higher than average found in commercial markets. The debt will be written off 30 years after the first April you were first due to repay. All student loan payments are made at the same time as income tax and NI and are managed as a part of the PAYE system. Therefore, it is helpful to imagine that any income over £27,500 will receive an extra 9% tax.
Interest Tax
A tax is also applied to interest generated on savings. If your annual salary is in the Basic Rate band then you receive £1,000 of interest free savings. £500 if in the Higher Rate and £0 in the Additional Rate. If a person's annual income is less than £17,570 then they will receive the difference between their Salary and their Personal Allowance deductions up to £5,000 as Starter Rate savings interest tax which is 10%. Here is a worked example: "You earn £16,000 of wages and get £200 interest on your savings. Your Personal Allowance is £12,570. It’s used up by the first £12,570 of your wages. The remaining £3,430 of your wages (£16,000 minus £12,570) reduces your starting rate for savings by £3,430. Your remaining starting rate for savings is £1,570 (£5,000 minus £3,430). This means you will not have to pay tax on your £200 savings interest." The Basic Rate of tax on interest is 20% up to £37,700. The Higher Rate band of tax on interest is 40% between £37,701 to £125,140. The Higher Rate band of tax on interest is 45% for anything over £125,141. A table of the rates is below:
£0 - 37,700 : 20%
£37,701 - £125,140 : 40%
£125,141 - ad infinitum : 45%
Bonuses
Additional Bonus income can make the tax calculation quite tricky as the tax code and rates are based on the total salary supplied by an employer. Large one off payments such as bonuses can push a person into a higher tax bracket and in some cases cause a person to be given the Emergency Tax code. Certain company types can have special rules when it comes to taxes. For example, members of an EBT receives a tax-free bonus of £3,600.
VAT
Value Added Tax (VAT) is an indirect tax on a person's income. When any goods or services are bought, VAT is applied to the price. For almost everything the Standard Rate is applied which is a flat 20%. The Reduced Rate is 5% but this only applies to a few specific items and the No Rate of 0% is even rarer. Certain things such as financial services and property sales are exempt from VAT and instead use the Captial Gains tax.
Worked Example (no longer accurate)
Below is a fully worked out example of a monthly payslip using tax code and full workings for total deductions from taxes. This example will not include any debt payments such as student loans, deductions due to paying into pensions, additional bonuses or taxable benefits.
Total Income /annum: £150,000
Income /month: £12,500
Tax Code: 0T
Income Tax:
Personal Allowance /annum = £0
Personal Allowance /month = £0
Basic Rate /annum = £10,054
Basic Rate /month = £838
Higher Rate /annum = £29,948
Higher Rate /month = £2,496
Additional Rate /annum = £11,187
Additional Rate /month = £932
Total /annum = £51,189
Total /month = £4,266
National Insurance:
Rate 1 /annum = £4,523
Rate 1 /month = £377
Rate 2 /annum = £1,995
Rate 2 /month = £166
Total /annum = £6,518
Total /month = £543
Total Deductions /annum = £57,707
Total Deductions /month = £4,809
Total Received /annum = £92,293
Total Received /month = £7,691
**All calculations have been rounded to the closest integer**