Income Tax - How it works (a users guide)

In the run-up to the upcoming UK general election, I have had quite a few interactions on social media with people discussing the various tax policies of the main parties. It has been quite clear to me, and on more than one occasion directly pointed out to me, that most people really don't understand how our current Income Tax system works, let alone the proposals in the manifestos. So, as ever I'm here to help (and also to hopefully help as many people as possible without having a million-and-one Twitter conversations to achieve it!).

Income Tax

• At the moment you all get a £12,500 personal allowance before you pay any Income Tax;
• After that, the next £37,500 is taxed at 20%. So, your maximum Income Tax bill is £7,500 if you earn £50,000 a year (we'll come on to National Insurance later);
• Above £50,000 (that's your £12,500 personal allowance and £37,500 20% band), you'll pay Income Tax at 40% (but only on everything above that figure);
• If you're fortunate (or unfortunate in tax terms) to earn above £100,000 a year, then you lose your personal allowance by £1 for every £2 you earn above £100,000. This creates an effective 60% Income Tax rate between £100,00 and £125,000;
• Between £125,000 and £150,000 you're back to paying just 40% Income Tax on that slice of income; and finally
• Above £150,000 you will pay 45% Income Tax.

Footnote: there are different rates of tax for dividends (7.5%, 32.5%, and 38.1%), and there are other Income Tax reliefs.

So, as you can see our current Income Tax system is about as clear as mud, and that's before we've even got on to National Insurance...

National Insurance

Unfortunately, despite many promises, the National Insurance (NI) system has never quite been aligned to Income Tax. However, it is somewhat simpler than Income Tax:

• On your first £8,632 you pay no NI;
• Between £8,632.52 and £50,024 you pay NI at 12%; and
• Over £50,025 you pay NI at 2%

Footnote: there are different rates for the self-employed, and if you take your remuneration from your business as a dividend there is no NI on that.

So, assuming you're an employee (things are a little for the self-employed/company owner) that's how tax works. Unfortunately, there seem to be a lot of people out there who think when you breach a certain tax band you pay that rate on all your income, not so my friends...

Finally, Labour's 45% above £80,000. How much difference will it make? Well, for every £1,000 over the threshold you earn you'll pay an extra £50 a year, or 96p a week. Doesn't even buy a cup of coffee does it? If you're lucky enough to earn £100,000, then it'll cost you £1,000 a year, or £19.23 a week (about the cost of a McDonalds for a family of four). Not as horrendous as it sounds when you think about it...