Tax is boring. I get it.
But understanding your Taxation is vital if you want to understand and grow your net worth.
Everyone thinks: ‘How can I pay less tax?’ Pay your fair share! For the public services we all rely upon!
But you shouldn’t be paying more than you need to.
Many don’t understand basic Personal Taxation. This article will help you understand the very basics of Personal UK Taxation as of 2019/20.
What is an Income Tax Band?
Income Tax Bands are levels of earnings at which you start paying more tax on those earnings.
Tax Bands only applies to earnings within the band.
If you earn £100,000 you are a ‘higher rate’ earner, in the 40% ‘higher rate’ band. Many think you pay 40% tax or £40,000:
Wrong! It is not the case. Half of your earnings are in lower Tax Bands. It looks more like this:
You’d actually pay £27,500 tax, across three bands:
- The nil rate band you pay nothing on your first £12,500 of earnings.
- The Basic rate band you pay 20% on your next £37,500 of earnings.
- The Higher Rate band you pay 40% on your next £100,000 of earnings.
What is the Personal Allowance?
In the UK, everyone can earn a certain amount of money without paying tax on those earnings. This is the Personal Allowance.
The Personal Allowance for 2019/20 is £12,500. This means the first £12,500 you earn in the year is completely tax-free.
The Personal Allowance is the first tax band, the nil rate or 0% band
Personal Allowance Adjustments
Your Personal Allowance can go up and down depending on your tax situation. Some Taxable Benefits reduce your Personal Allowance. Some Tax Rebates or other Allowances increase your Personal Allowance.
Reducing your Personal Allowance:
- Taxable benefits from your work, like Private Health Care
- Earning over £100K
- Previous year(s) underpayment of Tax
Increasing your Personal Allowance:
- Allowable expenses, like if you work from home
- Relief from Pension Contributions
- Marriage Allowance
- Some benefits, i.e. Blind Person’s Allowance.
- Charitable Donations via Gift Aid
- Previous years(s) overpayment of Tax
PAYE or Pay as You Earn
If you are employed in the UK, you will be taxed at source. Your employer will deduct tax from your gross salary on behalf of Her Majesty’s Revenue and Customs (HMRC). Your employer then pays your tax to HMRC.
You don’t need to do anything else. You will be paid net.
You can find your taxation on your payslip provided by your employer.
What is a Tax Code?
If you are employed in the UK, your Tax Code will be 1250L if you are entitled to the full Personal Allowance. You can find your Tax Code on your payslip.
To work out your personal allowance, the general rule is to multiply the number in your tax code by 10.
If my tax code is S1050L my personal allowance is 1050 * 10 = £10,500. This would mean I’ve had deductions from my Personal Allowance of £2,000, and I am taxed under the Scottish Tax bands.
See the full list of UK Tax Codes on gov.uk
What are the UK Income Tax Bands?
For 2019/20 the UK Tax Bands are:
| Band | Taxable Income | Tax Rate |
|---|---|---|
| Personal Allowance | Up to £12,500 | 0% |
| Basic rate | £12,501 to £50,000 | 20% |
| Higher rate | £50,001 to £150,000 | 40% |
| Additional rate | over £150,000 | 45% |
As I live in Scotland, it’s worth mentioning the Tax situation at home. In Scotland, Taxation is devolved to the Scottish Parliament. This means Scotland can set its own Income Tax Bands, which it does.
The Scottish Tax Bands are:
| Band | Taxable Income | Tax Rate |
|---|---|---|
| Personal Allowance | Up to £12,500 | 0% |
| Starter rate | £12,501 to £14,549 | 19% |
| Basic rate | £14,500 to £24,944 | 20% |
| Intermediate rate | £25,945 to £43,430 | 21% |
| Higher rate | £43,431 to £150,000 | 41% |
| Additional rate | over £150,000 | 46% |
This means taxation in Scotland is more Progressive than in England, Wales and Northern Ireland.
What is Progressive Taxation?
Tax Bands are an attempt to tax lower earners less, and higher earners more. This is a form of progressive taxation, where those who earn more pay more tax.
Earning £12,500. you would pay 0% tax.
Earning £60K you would pay £11,500 in tax, or 19.1% tax.
Earning £100K you would pay £27,500 in tax, or 27.5% tax.
Earning £100K in Scotland you would pay £29,544 in tax, or 29.5% tax.
What happens if I am a High Earner?
In the UK, if you earn over £100,000 your personal allowance is reduced by £1 for every £2 you earn over £100K. So if you earn £125K you have no personal allowance. The effect of this means you’d pay £2,375 more in tax every year.
Higher Earners are hit in other ways.
A portion of your Child Benefit is due back if you earn between £50K and £60K. Over £60K you lose 100% of your Child Benefit via Income Tax clawback.
For very high earners, the Pension Allowance is tapered. The amount you can contribute to your Pension tax-free every year reduces by £1 for every £2 you earn over £150K to a cap of £230K. This means you’d lose out on £30K of tax-free pension contributions.
Income Tax, especially via PAYE is simple.
It’s so simple, it comes out of your payslip and most people don’t even notice.
Remember: you only pay the tax rate on your earnings within the band. This means you are paying less tax than you think!
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