How much tax you pay – tax allowances and tax rates

You’ve probably heard of your tax allowance, basic rate tax and higher rate tax. But do you know how much tax you’re supposed to pay?

Here, we explain how tax allowances and thresholds work and what they are for the current 2020/21 tax year.

Personal tax allowance

Your personal tax allowance is the amount of money you can earn, or income you can receive, without paying tax. In the tax year 2020 – 21 it’s £12,500. This means if you earn or receive less than £12,500 between 6 April 2020 and 5 April 2021, you won’t have to pay any tax.

Your income could include rental income, wages or earnings from freelance work, interest from savings and/or dividends from shares or investment funds you own.

Not all the money you receive is taxable. So that means you could receive more than £12,500 a year and still not pay tax.

Here’s a list of income that you could have to pay tax on:

  • Your wages if you’re employed, or profits from being self employed
  • Interest from savings accounts, over a certain amount
  • Dividends from shares, over a certain amount (a dividend is a share of the profit that a company makes)
  • Pension payments, including your state pension
  • Certain state benefits, including Jobseeker’s Allowance and Carer’s Allowance.

Starting rate for savings

If you’re on a low income, you can also earn interest tax-free through the starting rate for savings. It’s an allowance that means you can receive up to £5,000 a year in savings interest without paying tax. However, every £1 you receive from income sources that aren’t savings reduces your starting rate allowance by £1.

The easiest way to explain this is through an example. If you earn £12,500 a year and receive £4,000 a year in interest from your savings (which would mean you have a lot of savings!) you wouldn’t pay any tax. That’s because you would qualify for the full savings starting rate of £5,000.

If you were to earn £14,500 a year and receive £2,999 a year in savings interest, so your annual income would be £17,499, you would still be able to get interest on your savings tax free. But if you were to earn £15,000 a year and get £2,999 a year in savings interest, you wouldn’t qualify for the savings starter rate.

Income tax

Basic rate taxpayer

If you’re a basic rate taxpayer, you pay income tax at a rate of 20%. But you only pay that on your income or earnings above £12,500, not on the whole lot.

You pay this rate if you live in England, Wales and Northern Ireland. Scotland sets its own income tax thresholds and rates. Its personal allowance is the same as England, Wales and Northern Ireland, at £12,500, but it has a lower rate of income tax of 19% on money you earn between £12,501 and £14,585. This rate is called the starter rate.

In Scotland, you pay tax at the basic rate (20%) on earnings or income above £14,586 and below £25,158.

Higher rate taxpayer

You pay a higher rate of tax than 20% on money you earn or receive over a certain threshold. The threshold depends on whereabouts in the UK you live. In Scotland, There’s an intermediate rate of tax of 21% on earnings between £25,159 and £43,430.

In England, Wales and Northern Ireland, you pay tax at 40% on money you earn or receive over £50,000. You only pay tax at 40% on that part of your income. If you’re a ‘higher rate taxpayer’, you actually pay tax at two different rates (four in Scotland).

In Scotland, the threshold for the higher rate of tax is lower than £50,000 (it’s £43,431) and the rate of tax is higher at 41%.

Once you earn more than £100,000, you start to lose the personal allowance. You lose it at a rate of £2 for every £1 you earn above the £100,000 threshold. If you earn £110,000 a year you get a personal allowance of £7,500 a year.

If you earn £120,000 a year, you get a personal allowance of £2,500 a year. And once you earn over £125,000 a year, you don’t get the personal allowance at all.

Additional rate taxpayer

If you earn more than £150,000 a year, you pay tax at 45% in England, Wales and Northern Ireland and 46% in Scotland.

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