How Income Tax and the Personal Allowance works

Understanding how Income Tax works can seem confusing.  Knowing how Income Tax and the Personal Allowance work will allow you to figure out if you’re being paid the right amount and help you budget.

Should I pay any Income Tax?

Income Tax is charged on most types of income. The most common way is on your wages and salary from work.  But you also need to pay Income Tax on:

• profits, if you run a business
• interest and dividends from savings and investments
• rent you get if you’re a landlord. 

You don’t usually pay Income Tax on all your taxable income. This is because most people qualify for one or more allowances.

What is a Personal Allowance?

Everyone, including students, has something called a Personal Allowance. This is the amount of money you’re allowed to earn each tax year before you start paying Income Tax. 

For the 2021/22 tax year, the Personal Allowance is £12,570.  If you earn less than this, you usually won’t have to pay any income tax. 

Your Personal Allowance might be bigger if you claim Marriage Allowance or Blind Person’s Allowance. Or it might be smaller if you’re a high earner or if you owe tax from a previous tax year.

Check the most up-to-date Personal Allowance figures on the GOV.UK website 

How much Income Tax will I pay?

Income Tax is made up of different bands. This means as your income increases, so does the amount of Income Tax you pay.

The below shows the rates of Income Tax depending on how much you earn.

Rates of Income Tax

Income                                                        Income Tax bands 2020/21

£0 to £12,570                                              0%

£12,571 to £50,270                                    Basic rate: 20%

£50,271 to £150,000                                  Higher rate: 40%

Over £150,000                                             Additional rate: 45%

Remember, you don’t pay Income Tax at the same rate on all your income. You only pay the rate of Income Tax on your income in the bracket. For example, if you earn £52,000 a year, the Income Tax you’ll pay works out like this:

• Up to £12,570 there is no income tax on first £12,570
• Between £12,571 and £50,270, you pay 20% Income Tax on your next £37,500 income (£50,270 - £12,570 = £37,700)
• Between £50,271 and £150,000, you pay 40% on the final £2,000 of income (£52,000 - £50,270 = £1,730)

Calculate your income tax and National Insurance contributions for the current year on GOV.UK website

If you live in Wales, your Income Tax rates are now set by the Welsh Government. At the moment, these are the same as for England and Northern Ireland for the 2021/22 tax year.  If you live in Scotland, your Income Tax rates are set by the Scottish Government and are different. 

If you think you might have had Income Tax wrongly taken from your earnings, fill in the R38 form from HMRC to have it paid back to you.

National Insurance

National Insurance contributions are a tax on earnings and self-employed profits paid by employees, employers and the self-employed. They can help to build your entitlement to certain benefits depending whether you are employed or self-employed, such as the State Pension and Maternity Allowance. Some social security benefits will be dependant on payment of sufficient National Insurance Contributions.

How much you’ll pay in National Insurance depends on what kind of National Insurance you’re paying.

There are four main classes of National Insurance:

• Class 1is paid by employees and employers
• Class 2 is paid if you’re self-employed
• Class 3 is a voluntary contribution
• Class 4  is paid if you’re self-employed and have profits over a certain amount 

Class 1 National Insurance Rates 

If you’re an employee you start paying National Insurance when you earn more than £184 a week (2021/22).

The National Insurance rate you pay depends on how much you earn, and is made up of:

• 12% of your weekly earnings between £184 and £967 (2021/22)
• 2% of your weekly earnings above £967.

For example, if you earn £1,000 a week, you pay:

• nothing on the first £184
• 12% (£93.96) on the next £783
• 2% (£0.66) on the next £33.

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