Subtract Your Tax-Free Allowances
Now, let’s reduce your income by taking off tax-free allowances.
The most common one is the personal allowance, which is £12,570 for the 2023-2024 tax year. This amount isn’t taxed, so it immediately lowers the portion of your salary subject to tax.
You only need to pay income tax on earnings above this threshold, and different sources of income, including self-employment, are considered when determining your total earnings and tax obligations.
Other allowances may apply depending on your circumstances. For example, if you qualify for the blind person’s allowance, you get an extra amount added to your personal allowance.
Income from ISAs or certain benefits is also tax-free, so make sure you don’t include these in your calculations!
Apply Income Tax Bands
Once you’ve subtracted allowances, the remaining amount is your taxable income, and this is where tax bands come into play. The UK has a progressive tax system, so different parts of your income are taxed at different rates:
- 20% for basic rate taxpayers (up to £50,270).
- 40% for higher rate taxpayers (above £50,270).
- 45% for additional rate taxpayers (over £125,140).
Only the portion of your income in each band is taxed at that rate. For example, if your taxable income is £60,000, you’ll pay 20% on the first £37,700 (after your allowance) and 40% on the next £9,730.
Factor in National Insurance Contributions (NICs)
Don’t forget about National Insurance Contributions (NICs), which are separate from income tax. If you’re employed, you’ll pay:
- 12% on earnings between £12,570 and £50,270.
- 2% on earnings above £50,270.
If you’re self-employed, you’ll pay Class 2 NICs (a flat rate) and Class 4 NICs, which are a percentage of your profits.
NICs fund things like the state pension, so they’re important, even if they reduce your pay a bit.
Deduct Pension Contributions and Other Deductions
Next, take off deductions like pension contributions. If you’re enrolled in a workplace pension, these contributions come out of your gross salary and can reduce your taxable income.
Other deductions might include student loan repayments if your salary is above the repayment threshold or salary sacrifice schemes like childcare vouchers.
These can lower your taxable income and save you money in the long run!
Understand Tax Code Adjustments
Your tax code plays a big role in how much tax is taken from your salary.
A typical code like 1257L reflects the standard personal allowance, but your code might be adjusted if you receive benefits like a company car or need to repay underpaid tax from previous years.
Always double check your tax code on your payslip. If it’s wrong, you could be paying too much (or too little) tax!
