The income tax system in the UK is progressive, meaning the more you earn, the higher rate of tax you pay. There are several tax bands and rates that apply based on your taxable income. Understanding these tax bands and rates is important for planning and managing your finances. We provide an overview of the basic and higher income tax rates, explain how your earnings are taxed, and suggest strategies to legally reduce your tax liability.

Basic Income Tax

The basic income tax rate applies to taxable income between £12,570 and £50,270 for the 2022-23 tax year. This tax band is also known as the personal allowance. Any income earned within this band is taxed at 20%. For example, if your annual salary is £30,000, the first £12,570 is tax-free. The next £17,430 (£30,000 – £12,570) falls within the basic rate tax band and is taxed at 20%. So you would pay £3,486 in income tax (£17,430 x 20%).

Higher Rate of Income Tax

The higher rate of income tax is 40% and applies to taxable income between £50,271 and £150,000. This is the intermediate rate tax band. If your taxable income exceeds £50,270, the amount above the threshold is taxed at 40% instead of the basic 20% rate. For example, if your annual salary is £60,000, the first £12,570 is tax-free. The next £37,700 (£50,270 – £12,570) is taxed at 20% (£7,540). The remaining £9,730 (£60,000 – £50,270) falls into the higher 40% tax band. So you would pay £3,892 (£9,730 x 40%) in higher rate tax, in addition to the basic rate tax.

Additional Rate of Income Tax

There is one more income tax band above £150,000, known as the additional rate tax band. Income exceeding £150,000 is taxed at 45%, the highest income tax rate. This additional rate only applies to earnings above £150,000. If your total taxable income is below this threshold, you do not pay any additional rate tax regardless of your earnings.

Personal Allowance and Tax-Free Allowances

Besides the standard personal allowance of £12,570, other tax-free allowances can help reduce your taxable income. For example, you can earn up to £1,000 from self-employment, renting out property, or savings interest without paying any tax. Make use of all relevant allowances to minimize taxes.

Tax Reliefs

The government offers certain tax reliefs to encourage investments, savings, and pensions. These can help you lower your tax bill if utilized effectively. For instance, contributing to a pension plan entitles you to tax relief at your marginal income tax rate. So if you fall in the higher 40% tax band, a pension contribution of £100 only costs you £60. Other tax relief options include charitable giving, loss relief, marriage allowance, etc.

Tax-Free Savings and Investments

Some savings and investment vehicles have tax advantages. An Individual Savings Account (ISA) allows you to earn interest on your savings of up to £20,000 annually tax-free. Investing in an ISA rather than a regular savings account prevents your interest earnings from pushing you into a higher tax bracket. Some workplace pension schemes also offer tax relief on contributions.

Income Splitting

If you are married or in a civil partnership, you can legally split your income to minimize taxes. By transferring assets to your partner, you can make the most of each person’s tax allowance and lower-rate tax bands. Spreading income in this manner reduces your combined tax liability. However, income splitting must be genuine and not just for tax avoidance.

Understanding the marginal tax rates on your income enables smart tax planning and savings. Use all available tax-free allowances, reliefs, deductions, and exemptions. Contribute the maximum to tax-advantaged pension plans and ISAs. Consider spreading your income and assets across family members. Implement tax reduction strategies well before the end of the tax year to minimize your tax obligations legally and ethically. With prudent planning, you can pay only the necessary taxes and retain more of your hard-earned income. Contact our tax advisors for self assessment tax return and  deductible expenses and how to calculate and claim them on your tax return.