Income Tax – The Basics
This page explains the basic concepts of income tax in the UK. Specific tax bands relate to England, Wales and Northern Ireland. Scotland has its own income tax bands, but the concepts are the same.
Marginal Tax
Section titled “Marginal Tax”The UK operates what is known as a marginal tax system. Put simply, for every £1 you earn over a threshold, you only pay that tax rate on that income, not the whole lot.
A common misunderstanding here is that once you reach the 40% tax bracket you pay 40% on all your income and are therefore worse off. But instead you only pay 40% on anything within the 40% tax bracket.
An easy way to think about this is with an analogy. Imagine you have four buckets, and your tax is worked out by the amount of water (income) in each bucket:
- Personal allowance bucket. This isn’t very big, but water in this bucket isn’t taxed, and once it is full, water overflows into the…
- Basic rate bucket. This bucket is bigger, and only water in this bucket is taxed at the basic rate. It doesn’t affect the first bucket. Once this bucket is full the water overflows into the…
- Higher rate bucket. This is a larger bucket still and water here attracts higher-rate tax. Almost everybody has run out of water before this bucket is filled.
- Additional rate bucket. This bucket is unlimited in size, and only very few people will find themselves using it.
The point of this analogy is that the extra water poured in will not affect the water in any of the previous buckets – you’ve already filled those.
Tax rates, codes and allowances
Section titled “Tax rates, codes and allowances”The current rates for income tax in England, Wales and Northern Ireland, can be found on the Government website here. There are different rates if you live in Scotland.
What’s my personal allowance?
Section titled “What’s my personal allowance?”Put simply, your personal allowance is the amount you can earn without paying tax. This is determined by HMRC and is reflected in your tax code, given to your employer so they can deduct the correct amount of tax each month from your pay.
The “default” tax code is currently 1257L, which gives you an allowance of £12,570 before you start paying income tax. This resets at the start of every tax year which runs 6th April to 5th April the following year.
Some people have different tax codes which allow them to earn more, or less, each year without paying tax. If HMRC change your code, they’ll send you a letter explaining why. For example, a code of 850L would mean your personal allowance had been reduced to £8,500.
Worked example
Section titled “Worked example”Salary: £60,000. Assuming a 1257L tax code, you pay no tax on the first £12,570 and “some” tax on the remaining £47,430 (the 40% tax rate comes in at £50,270). This example ignores National Insurance Contributions.
| Income tax band | Rate | Amount |
|---|---|---|
| First £12,570 | 0% | £0 |
| Next £37,700 | 20% | £7,540 |
| Next £9,730 | 40% | £3,892 |
| Total: £60,000 | 19.05% effective | £11,432 |
Figures accurate for 2023/24 tax year.
In this example, personal allowance and basic rate buckets are full, but there is lots of space left in the higher-rate bucket. If a bonus of £10,000 was earned, this extra would be taxed at 40% (£4,000). It would bring the total tax paid to £15,432, or 22% of the £70,000 earned that year.
I’ve found another page on HMRC with different numbers for income tax bands?
Section titled “I’ve found another page on HMRC with different numbers for income tax bands?”Was it this page? It causes a lot of confusion. It is intended for employers, and reflects the rates to be applied to your income after your personal allowance.
Please use https://www.gov.uk/income-tax-rates instead!
My tax code is 1257L and I’ve been charged tax already, but I’ve not earnt over £12,570?
Section titled “My tax code is 1257L and I’ve been charged tax already, but I’ve not earnt over £12,570?”The standard tax code is what is called a cumulative tax code. This means you get 1/12th of your personal allowance each month (£1,047.50) before you start paying tax. This is so the tax deducted over the course of a year remains broadly consistent, rather than giving some months at the start with no tax, and then months towards the end with big deductions.
If you start work part way through a year, you’ll get previous months’ allowances credited against your first payslip, and these will roll over until you’re all caught up. This can result in paying very little tax for the first few months.
I have a different tax code, what does it mean?
Section titled “I have a different tax code, what does it mean?”The ones that come up the most are M1 and W1 at the end, which are “month 1” and “week 1” codes. In short, each month/week is taken in isolation, rather than averaging over the year like with a cumulative code.
The other codes to be aware of are the “emergency codes” – BR for basic-rate and D for higher-rate. These apply a flat rate of tax with no allowance given, and are often used for second jobs, but can also be applied incorrectly if HMRC aren’t provided with a P45 at the start of a new job.
HMRC have said I underpaid tax last year by £500, but they’ve taken £2,500 off my allowance?
Section titled “HMRC have said I underpaid tax last year by £500, but they’ve taken £2,500 off my allowance?”Your tax code determines how much income you pay tax on (or rather don’t pay tax on). By reducing your allowance by £2,500, that’s the extra income that will be subject to tax. For a basic rate payer, reducing your allowance by £2500 results in paying £500 more tax (20% of £2,500).
I’ve had a bonus this month why have I paid more tax than I should have?
Section titled “I’ve had a bonus this month why have I paid more tax than I should have?”The system for PAYE calculates tax based on the cumulative pay you have received to date. If you have one month with an unusually large pay (e.g. from a bonus) then this can result in you overpaying tax in that month.
This usually resolves itself over the rest of the tax year through paying a reduced amount of tax each month. If it isn’t resolved before the end of the tax year, HMRC will automatically refund the payment after the end of the tax year, around July or August.
I receive “benefits in kind” at work. How are they taxed?
Section titled “I receive “benefits in kind” at work. How are they taxed?”You may have joined a workplace Private Medical Insurance (PMI) scheme, or receive other perks on top of your salary. HMRC consider it to be a form of income, and will apply income tax to the amount, usually via a P11d notice.
Let’s say the cost of your membership in a PMI scheme is £100/month to your employer – HMRC add that to your salary, and tax the “benefit in kind” (£1,200 additional income assumed). If you are a basic-rate taxpayer, this results in £240 more tax for the year, and £480 more if you’re a higher-rate taxpayer.
This assumed additional income also impacts your ‘Adjusted Net Income’, which can have an effect on entitlement to Child Benefit and reduction of tax allowances for high-earners.
Not all workplace benefits are taxable. You can find information on this on gov.uk. One of the most common workplace benefits that is not taxable is “group death-in-service” schemes – life insurance provided by your employer, usually based on a multiple of your salary. Confusingly, this isn’t mentioned on the linked gov.uk information page.
I have stopped work and won’t have any more income this year, can I get a refund quicker?
Section titled “I have stopped work and won’t have any more income this year, can I get a refund quicker?”If you stop working part way through a year, it’s likely that you’ll have overpaid tax on this income. You can contact HMRC and inform them that you won’t have any further taxable income this year, and they’ll issue a refund for any overpaid taxes.
What about “tax traps” that I have heard about?
Section titled “What about “tax traps” that I have heard about?”There are some levels of earnings where disproportionately high amounts of tax are paid due to the removal of allowances. The two notable ones are:
- The loss of child benefit on earnings between £50,000 and £60,000.
- The loss of the personal allowance on earnings between £100,000 and £125,140.
We go into more detail about tax traps in our Tax Traps and Tax Efficiency page.
Do I need to complete a Self Assessment Tax Return?
Section titled “Do I need to complete a Self Assessment Tax Return?”Most employees with straightforward tax affairs do not need to complete a tax return. As we mention in our Savings Accounts page, if your taxable savings income exceeds £10,000 you will need to.
Other times that you may need to are detailed on this gov.uk help page.
How can I work out what my take home pay should be?
Section titled “How can I work out what my take home pay should be?”If you are looking at changing jobs, or have recently been promoted, you may want to estimate what your take-home pay should be. There are lots of net pay calculators online but the two that get most recommendations from the subreddit are Listen to Taxman and The Salary Calculator.
These calculators are only as accurate as the information provided – this means entering the correct tax code, accurate pension contributions, and so on.
Personal Tax Account
Section titled “Personal Tax Account”A lot of tasks related to the tax you pay, such as updating your predicted income for the year, or reclaiming overpaid tax if you leave employment can be managed through your personal tax account.
The HMRC personal tax account page can be accessed here: https://www.gov.uk/personal-tax-account.
If you’ve not used the account before, you’ll need to register. This does require some personal information, so make sure you have your ID and a recent payslip to hand when you register.
National Insurance
Section titled “National Insurance”National Insurance contributions are often seen as another tax on your income, but they work in a slightly different way to Income Tax. The rates are the same for the whole of the UK, including Scotland.
People earning through the Pay As You Earn (PAYE) system will be subject to Class 1 National Insurance contributions, and most will pay Category A contributions:
| Weekly Income Band | Monthly Income Band | NI Rate |
|---|---|---|
| £0 – £242 | £0 – £1,048 | 0% |
| £242 – £967 | £1,048 – £4,189 | 10% |
| £967 and above | £4,189 and above | 2% |
Figures accurate for 2023-2024 tax year, following changes in January 2024.
When multiplied out, these thresholds work out the same as the standard income tax thresholds in England, however unlike income tax, National Insurance is calculated per pay period. This means that if you earn more one month, you’ll pay more National Insurance, which you won’t get back over the rest of the year.
Employees do not have to pay Class 1 National Insurance contributions before the age of 16 or once they reach state retirement age.
There are other classes of National Insurance. The self-employed pay Class 2 or Class 4, and you can choose to pay voluntary Class 3 contributions to maintain a state pension record if you do not earn enough otherwise.
Tax on Savings and Investments
Section titled “Tax on Savings and Investments”We go into lots of detail about tax on cash savings on the Savings Accounts page.
You may also receive interest or dividends from stocks and shares that you own. If these are owned outside of ISAs or Pensions, they are taxed as income.
The important thing to remember in relation to overall taxation, is that savings and investment income is always added to the buckets last, after any earned income, and so always attracts the highest marginal rate of tax.