Income Tax and National Insurance Explained


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By Crispin Bateman

on Tuesday 16 July 2019


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What is national insurance and income tax?

Part of society means that we must help pay for all the services and national infrastructure that helps the country work, but do you really understand what the money you pay is, how it works and what it’s used for?

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In this article, we take an in-depth look at national insurance and income tax, and we explain what you will pay and why.

The difference between national insurance and income tax

For most employed people in the UK, both national insurance and income tax are taken from your salary before you even see it and can feel part of the same thing. However, they are different and are used in very separate ways.

One is all about the country as a whole and the other (though this may surprise many) is about you.

What is national insurance?

National insurance is tied to you and your part in the welfare state. At its most basic, national insurance contributions are the money that you and your employer pay into the system, and benefits like unemployment benefit, invalidity benefit, jobseeker’s allowance and other state benefits pay out of the system.

Most importantly, your national insurance contributions determine the level of state pension you will be allocated once you reach pension age.

What is income tax?

Different to national insurance, income tax is money taken from your salary (and other income) to pay for the country as a whole. Income tax is the government’s main source of income, making up 30% of all money generated in the country. It pays for the NHS, education, roads, defence and infrastructure among other things.

What age do you start paying tax and national insurance?

All working people in the UK pay income tax, provided they earn enough.

Many believe that if you are under 18, or under 16, that you do not have to pay income tax. Unfortunately, this is a myth and the threshold for paying tax is about earnings (currently £11,000 per year) and not age.

If you are a student, a child actor, or an entrepreneurial teenager, you can expect to pay tax if you make enough money.

National insurance is somewhat different, and you only become obligated to pay that once you pass the age of 16.

How much can you earn before tax?

Not paying tax (or paying as little as possible) is a huge aim for many working people across the country. Though we all appreciate the benefits gained from many government-paid areas, no one actually likes to pay for it. Knowing how much you can earn before paying tax, or what you can do to limit your tax bill is important to managing your personal finances.

It’s also a huge political point, and many governments rise and fall over their tax policies.

Tax is paid in bands as follows (note that Scotland has different bands):

Personal tax allowance

The personal tax allowance is the amount you can earn without HMRC taking any tax from you. For the 2019/2020 tax year, it is set to £12,500. This means that if you earn £1000 or less per month, you will be taxed nothing on it. You must still declare your earnings, either through your employer as part of the PAYE scheme, or through regular tax returns submitted directly online to HMRC.

Your personal tax allowance forms the first band of your income tax payment, meaning that money will always be exempt of tax even if you earn more than it (the tax will only be calculated on the money past the personal allowance).

Those who earn more than £125,000 (ten times the personal tax allowance) no longer get a personal tax allowance and must pay tax on all their income.

The basic rate

Currently, the basic rate is 20% and covers your income from £12,501 to £50,000 p.a.

This means that 20% of the money you earn that falls in the basic rate will be paid in tax. Again, if you earn more than £50,000 and move into the next band, your basic rate will still apply to this money and it will be taxed at 20% and not higher.

The basic rate covers most earners in the UK.

An example of basic tax rate and the personal allowance:

Tom earns £33,000. After the personal tax allowance, £20,500 is eligible for tax at 20%. Over the year, Tom must pay £4,100 in tax. Through PAYE, this is taken monthly from his gross salary, and Tom finds himself paying £341.67 per month in income tax.

The higher rate

The higher rate of 40% applies for all income earned between £50,001 and £150,000 - it works identically to the basic rate band.

An example of tax up to the higher rate:

Sally earns £84,400 p.a. Of that, £34,400 is in the higher rate and is taxed at 40%; £37,500 falls into the basic rate of 20%; £12,500 is her personal tax allowance.

Sally pays a total of £21,260 in tax over the year, or £1,771.67 each month.

The additional rate

The additional rate of tax for 2019/2020 is 45% on all income over £150,000.

Due to the loss of the personal tax allowance for anyone earning more than £125,000, all people paying the additional rate of tax no longer have a free tax bracket of £12,500.

An example of tax up to the additional rate:

Michael earns £245,000 per year. It is broken down as £37,500 in the basic rate; £112,500 at the higher rate; and £95,000 in the additional rate.

He pays a total of £95,250 in income tax that year.

Table of Tax Rates in the UK (not Scotland) 2019/20

Personal Tax Allowance

Up to £12,500

0%

Basic Rate

£12,501 to £50,000

20%

Higher Rate

£50,001 to £150,000

40%

Additional Rate

£150,001 and higher

45%

How much national insurance do you pay?

Unlike income tax, your national insurance is based on your weekly income, rather than your annual salary. While this can be a similar calculation in long-term stable employment, it will fluctuate more for those in less regular jobs.

For most employed people in the UK, national insurance contributions (NIC) are made by both you and your employer – you will pay as follows:

  • Earnings up to £166 per week: 0%

  • £167 to £962 per week: 12%

  • £963 and above: 2%

Your employer must add to this with a flat 13.8% for all earnings above £166 per week.

An example:

John earns £1000 per week, the first £166 is under the national insurance threshold and he doesn’t pay any NIC on it. The next £796 is paid at 12% totalling £95.52, and the last £38 requires 2% contribution (76p). His total NIC for the week are £96.28.

John’s employer adds to this with 13.8% of £834, or £115.09.

How to pay tax – the PAYE system

PAYE (or Pay As You Earn) is the system by which employed people in the UK pay their tax, national insurance and other pension contributions. The system is designed to be relatively simple and with minimal administration.

It works by HMRC issuing everyone a tax code in the UK. This tax code details how much tax and national insurance you should pay and can be applied by the payroll team at your work to make sure you pay the correct level of tax.

The money is then taken from your salary before it is paid to you. The remaining amount is then paid to your bank account and a payslip detailing your tax code, the deductions taken, and your final net take home amount is provided.

Your salary prior to the tax being paid is called your gross income, and the amount once this is taken, your net income.

This system means that employed people across the UK don’t have to personally administer their taxes or look for help to do so, allowing you to get on with your job and not have to spend extra hours worrying about money owed to the government.

It is not immune to error, however, and you should always check your payslip to make sure all the details are correct – including your tax code.

Income tax and national insurance for the self-employed

Take away the umbrella of a company and their bookkeepers and accountants and everything becomes a little more complicated.

People who are self-employed are responsible for filing their own tax returns and paying their income tax and national insurance accordingly. This can be done yourself, or it can be done through a third-party accountant. With the right software and a recent move from the government towards making tax digital, dealing with your own accounts as a self-employed person has never been easier, yet it can still be a complicated and frightening arena that’s easily handled by a professional.

At Compare UK Quotes, we offer the best advice we can regarding your personal and business finances, and we recommend getting an accountant to manage your yearly finances.

A good accountant will take the headache away from this side of the business and leave you to do the work you became self-employed to do! The amount spent on your yearly accounts will be minor, and the amount of tax your accountant will save you probably makes them a profitable investment!

Of course, however, there’s no legal requirement for you to employ a third-party bookkeeper or accountant, and you are free to submit your tax return yourself.

Income tax for the self-employed is no different to that for the employed. You still have the same personal tax allowance and your tax is calculated using the same bands. National insurance, on the other hand, is dictated somewhat differently.

Employed people pay Class 1 national insurance contributions – those who are self-employed come under Class 2 or 4 for their NIC.

Class 2 is a basic £3 per week if your self-employed profits are below £8,632 for the year. Class 4 is 9% on profits between £8,632 and £50,000, and 2% for profits above £50,000.

Both tax and national insurance for the self-employed are paid directly to HMRC.

Tax and national insurance FAQs

What do the tax codes mean?

Your tax code is provided by HMRC for the year, it is worked out based on your personal allowance, your income and any tax you have already paid. While you might have the same tax code as a colleague, many things from a second job, to a period where you were self-employed, or the day you started employment can all affect your code.

It is possible to ‘read’ your tax code and work out its meaning. For example, it is normally the amount of salary you can earn before paying tax (your personal allowance) divided by ten and followed by a letter. A code of 1250L indicates a personal allowance of £12,500 and is typical for the 2019/20 tax year.

Letters at the start of your tax code can also tell you important information, codes that begin with K show that you still owe tax from previous years, those without numbers or that start with a D indicate a secondary job or other situation where you have used your personal allowance elsewhere.

A tax code starting BR shows you are being taxed without a personal allowance at the basic rate, and could indicate that your employer doesn’t have all the information they need to properly calculate the right tax – or it could be another marker to show this is a second job.

How much is emergency tax? What is emergency tax?

If you have started a new job, you may be allocated an emergency tax code until your employer can get your full tax details. This tax code (which will end W1, M1 or X) will give you your personal allowance and put you on the basic rate – very often the correct level of tax anyway – but it may mean you are out of pocket for a little while.

It can take a couple of months for an emergency tax code to be replaced with a regular one, and if you have overpaid your tax, you will be issued with a rebate.

If I get a second job, do I pay more tax?

Your tax is based on your total income – all of which is reported to HMRC. If you have a second job, the chances are that your personal allowance is already used up on your first, so it may seem that you are taxed to a greater extent, but that’s really not the case. You only get one personal allowance, even if you have multiple jobs.

A second job might also move you into a higher tax band, and in that case you will start paying tax at the higher rate for the work done there.

HMRC will expect you to detail one job as primary, and one as your second job – this helps them allocate the right tax codes to each, but doesn’t change the tax you will pay over the year.

How do I get a rebate?

If the tax office owes you money, they will inform you and pay you accordingly. If you believe you are entitled to a rebate because you have paid too much tax, talk to your employer or call HMRC directly.

What happens if I don’t pay national insurance?

If you owe national insurance or income tax, then you must pay it by law, however there are certain periods where you might legitimately not pay national insurance. These include periods of low income, being unemployed but not claiming benefits or living abroad.

The state pension is heavily affected by the number of years you have not paid your national insurance contributions. For this reason, you might want to pay voluntary class 2 national insurance contributions at a low rate during the times you are not otherwise paying them.

Read our guides on pensions to find out more about the state pension.

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