How Income Tax, National Insurance and the Personal Allowance works
Unsure about Income Tax and National Insurance? Don’t know what the National Insurance threshold is? Unsure how the Personal Allowance applies to you? We explain how the tax system works and what to do if you think you’re overpaying.
- Should I pay any Income Tax?
- The Personal Allowance if you earn over £100,000
- What is Income Tax used for?
- How much Income Tax will I pay?
- National Insurance
- What do you pay National Insurance on?
- Voluntary ‘Class 3’ National Insurance rates
- Voluntary ‘Class 2’ National Insurance rates
Should I pay any Income Tax?
Income Tax is charged on most types of income, such as wages and salary from jobs, your profits if you run a business, pensions, rents you receive if you’re a landlord, and interest and dividends from savings and investments.?
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You don’t usually pay Income Tax on all of your taxable income. This is because most people qualify for one or more allowances. An allowance is an amount of otherwise taxable income that you can have tax-free each tax year.
1 Reduced by £1 for every £2 above income threshold until it reaches £0.
2 20% of this allowance is given as a reduction in your tax bill (unlike the Personal Allowance and Age Allowance which are deducted from your taxable income before tax is worked out).
3 £1,000 for basic-rate taxpayers; £500 for higher-rate taxpayers; £0 for additional-rate taxpayers.
Most allowances are increased each year and increases apply from the start of the tax year, 6 April.
Jump down to ‘How much Income Tax will I pay?’ to find out what you’re liable for.
What is a Personal Allowance?
Everyone, including students, has something called a Personal Allowance – the amount of money you’re allowed to earn each tax year before you pay Income Tax. Your Personal Allowance may be bigger if you claim Marriage Allowance or Blind Person’s Allowance, or smaller depending on your income or if you owe tax from a previous tax year.
The tax year runs from 6 April to 5 April, and for the 2019-20 tax year the standard Personal Allowance is £12,500. The Personal Allowance will also be set at £12,500 for 2020/21 tax year and then indexed with the Consumer Price Index (CPI) from then onwards.
If you earn less than this, you normally shouldn’t have to pay any Income Tax.
The amount of the Personal Allowance you receive is set by the government and can change from one tax year to the next.Check the most up-to-date Personal Allowance figures on GOV.UK.
The Personal Allowance if you earn over £100,000
For people earning over £100,000, the figure of £12,500 will be reduced by £1 for every £2 earnt. When someone earns £125,000 Income Tax is paid on everything earnt and there’s no tax-free allowance.
What is Income Tax used for?
Your Personal Allowance is taken off your earnings before you start paying Income Tax.
Income Tax is collected by HMRC on behalf of the government. It’s used to help provide funding for public services such as the NHS, education and the welfare system, as well as investment in public projects, such as roads, rail and housing.
How much Income Tax will I pay?
From April 2019, the standard Personal Allowance will increase to £12,500, with the higher rate tax threshold increasing to £50,000.
Income Tax is made up of different bands. This means that as your income increases so too does the amount of Income Tax you pay.
It’s an attempt to make paying Income Tax as fair as possible so that those who earn the most contribute more.
The table below shows the rates of Income Tax depending on how much you earn.
If you live in Wales, income tax rates are now set by the Welsh Government. These are currently the same as for England and Northern Ireland in the 2019/20 tax year. If you live in Scotland, the rates are different.
If you think you might have had Income Tax wrongly taken from your earnings, fill in the form from Her Majesty’s Revenue and Customs (HMRC) to have it paid back to you.Get the R38 form to reclaim tax on GOV.UK, or contact HMRC.
National Insurance contributions are a tax on earnings paid by employees and employers and help to build your entitlement to certain state benefits, such as the State Pension and Maternity Allowance.
Unlike Income Tax, National Insurance is not an annual tax. It applies to your pay each pay period (which might be monthly, weekly or some other period depending on your employer’s arrangements). This means if you earn extra in one month, you’ll pay extra National Insurance, but you won’t be able to claim the extra back even if your pay is lower during the other months of the tax year.
You begin paying National Insurance once you earn more than £166 a week (this is the figure for the 2019-20 tax year).
The National Insurance rate you pay depends on how much you earn:
- 12% of your weekly earnings between £166 and £962
- 2% of your weekly earnings above £962.
Your National Insurance contributions will be taken off along with Income Tax before your employer pays your wages.
Until April 1977, some older married women and widows who pay National Insurance contributions at the Married Women’s Reduced Rate could choose to pay a reduced rate of national insurance. You might still be paying the reduced rate if you opted for this before the scheme ended. The reduced rate is 5.85% of weekly earnings between £166 and £962 instead of the standard rate of National Insurance of 12% on earnings. As a result, your State Pension could be reduced and your ability to claim some contribution-based benefits could be negatively impacted.
Employee’s National Insurance contributions stop once you reach State Pension age.Find out more about your National Insurance contributions on GOV.UKopens in new window.
What do you pay National Insurance on?
Both you and your employer must pay National Insurance contributions on your earnings – including holiday pay, sick pay and maternity pay – and, in most cases, any reward you get that can be easily converted to cash. But there are exceptions – for example, if part of your pay is shares in your employer’s company using a tax-approved share scheme.
Part of your pay may be in the form of benefits in kind. As an employee, there is no National Insurance on benefits in kind. However, with some exceptions, employers do have to pay National Insurance on the value of any benefits in kind that they provide you with.
What do National Insurance payments pay for?
Your National Insurance payments go towards state benefits and services, including:
- the NHS
- the State Pension
- unemployment benefits
- sickness and disability allowances.
Voluntary ‘Class 3’ National Insurance rates
Class 3 voluntary National Insurance contributions are designed to fill in any gaps in your National Insurance record to get a higher State Pension.
To receive the full new State Pension, which is payable to people who have reached their State Pension age on or after 6 April 2016, you’ll need to have 35 qualifying years of National Insurance contributions.
Anyone with less than this will receive a reduced State Pension. To receive the new State Pension you need to have a minimum of 10 qualifying years.
If you don’t have 35 qualifying years, you may want to consider paying Class 3 voluntary contributions to boost your pension entitlement.
In 2019-20, Class 3 contributions are payable at a weekly rate of £15. This is the maximum you can pay each week.
You may not always be able to pay Class 3 contributions (or Class 2) for a tax-year. That’s why it’s important to find out whether you can make payments towards any gaps, how much you will need to pay, and what benefit (if any) you would get by making a voluntary payment before deciding whether to pay any voluntary National Insurance Contributions (NICs).For further information on paying voluntary Class 3 National Insurance contributions and to check your national insurance record visit the GOV.uk website.
Voluntary ‘Class 2’ National Insurance rates
If you’re self-employed or have been working abroad, you may be able to pay voluntary Class 2 contributions instead.
Class 2 NICs are currently flat-rate weekly contributions of £3.00 per week in 2019-20. You’ll need to pay them for every week or partial week of self-employment in a tax year if your profits for the entire tax year are £8,632 (the Small Profits Threshold) or more in 2019-20.
Payment of Class 2 contributions is voluntary for self-employed people with profits below the Small Profits Threshold. Paying Class 2 NICs even if your profits are lower can still help you build contributory entitlements to benefits.
This can be a specialist area and it’s best to take advice based on your individual personal circumstances.