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Confused About Income Tax? Here’s A Quick, Easy Guide

Financial advice
By July 9, 2018

Tax treatment depends on your personal circumstances and is subject to change.

The value of pensions and investments, and the income they produce can fall as well as rise. You may get back less than you invested.



Need a quick, simple guide to income tax in the UK? Look no further.

Income tax, of course, is the tax you pay on your earnings. This seems simple enough, but beyond that it can start to get quite complicated.

Even people who have been working for a long time can get confused by income tax. In fact, often people with highly complex finances would do well speaking with a financial adviser.

Questions abound. How does PAYE work, for instance?

What about tax on other sources of income, apart from your salary?

What about income tax if you are retired, or paying into a pension?

As a Chartered Financial Planner based in Cheadle, I am well versed on these subjects. It’s our job to explain complex financial matters to clients in a way that is easy to understand.

As such, this is our quick, easy guide to income tax in the UK.


Income Tax: A Brief Overview (2018-2019)

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Tax bands are not static, so this is how they stand at the time of writing:

0% tax: earnings up to £11,850 (your “Personal Allowance”)
20% tax: earnings between £11,851 and £46,350 (Basic Rate)
40% tax: earning between £46,351 and £150,000 (Higher Rate)
45% tax: anything above £150,000 (additional rate)

PAYE (Pay As You Earn) is a way the UK government collects your income tax, as well as your national insurance contributions if you are an employee.

Under this system, your employer will deduct these taxes and contributions from your wage, before you receive it in your bank account.

Your Personal Allowance means you can earn up to £11,850 per annum, before you pay tax. However, you may be entitled to claim other tax benefits, too.

For instance, the ‘Married Couples Allowance’ provides that if you are married (or in a civil partnership) and living with your spouse/partner and you were born before 6 April 1935, and your household income is low, then you and your spouse may be eligible to an additional allowance of up to £8,695*.

(*This is a tax-reducer, that is to say, they allow a reduction in any tax-payable at a rate of up to 10% of the stated allowance)

For those born after 1935, who are married or in a civil partnership, there is the Marriage Allowance. This permits a transfer of 10% worth of the personal allowance, from one party to another, useful if their full personal allowance in not being used (maybe work part-time, or not at all) while the other party is a basic rate taxpayer.


How Income Tax Relates To Other Taxes


As a Chartered Financial Planner, I often come across clients in and around our office’s in Cheadle, who have multiple income streams, which can complicate their tax situation.

One common income stream includes dividends. This is where you own shares in a company (often your own company, but any company (including Unit trusts and OEICs really). You earn money from them either by:

  • Selling the shares for profit
  • Receiving dividends (i.e. a share of the company’s profits)

You can earn up to £2000 each year from Dividends, without having to pay tax. This applies to dividends received in collective investments well.

There are also other allowances to think about. For instance, you can earn up to £1000 from your property before a tax is levied (e.g. renting out your driveway).

You can also earn up to £1000 from trading activities (e.g. selling on eBay), tax free.

Note, that there is also a ‘Rent-a-Room’ allowance whereby as the name suggests, you let out a room in the house in which you live yourself. This is more substantial the aforementioned ‘Property’ allowance, allowing you to earn £7,500 each year exempt from tax.


Important Tax Reliefs

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All of us have expenses. However, sometimes these can actually be claimed to reduce your tax bill.

The way this works is that you can subtract certain expenses from your pre-tax income (i.e. your gross income).

This means that, on paper, certain expenses actually be claimed to reduce your wage. So, because the UK government sees you as earning less, you get taxed less.

Interest payments on certain loans can be treated in this way, for instance. (Although not mortgages or property bought for personal use).

For example, if you earn £35,000 a year and you are paying £4000 interest payments on a (Qualifying) loan, then you can arrange to deduct the latter amount from your salary.

This means you would be paying income tax on £31,000, rather than on £35,000.


Tax Relief On Pension Contributions


If HMRC (Her Majesty’s Revenue & Customs) has approved the pension scheme you’re paying into, then you will get tax relief on these contributions.

You can get tax relief on pension contributions on the lesser of £40,000 or 100% of your earnings. Please note that if you earn more than £150,000 your annual allowance will be lower.

The absolute, annual contribution limit however, is £40,000. So bear that in mind.

If you have an occupational pension, then whatever you put into it each month will occur before tax is calculated on your wage. This effectively gives you an immediate tax relief.

Things work differently if you have a stakeholder pension, or personal pension. In these cases, your contribution to the pension is made after your employer has deducted tax and NIC, then the pension provider claims the tax relief at the basic rate on your behalf. If you are a higher rate taxpayer you then need to claim any higher rate relief via your self-assessment.

So, if you put £150 into a pension like this, the scheme administrator will claim an additional £37.50 from HMRC. (I.e. 20% of the contribution, which assumes you are a Basic Rate taxpayer).

In this case, this would bring your total monthly contributions up to £187.50.


Next Steps


We said this would be a simple, easy guide to income tax. However, this is really only scratching the surface and there is much more to consider.

Your financial situation, moreover, is broader than just your present income streams. It’s important to also consider your longer term goals, investments, pension plans and more. If you are looking to optimise your finances, make your wealth more tax efficient or wisely, arrange a pension plan, then do get in touch.

Tax treatment depends on your personal circumstances and is subject to change

The value of pensions and investments, and the income they produce can fall as well as rise. You may get back less than you invested.



Kevin O’Neill, APFS
Chartered Financial Planner
O’Neill Financial Services
(T) 01260 272746
(e) Info@OFS.Financial


The Financial Conduct Authority does not regulate tax planning advice.

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