If you work and live in the UK, understanding the intricacies of tax and National Insurance is crucial to managing your finances effectively. Taxes and National Insurance contributions are key components of the UK’s revenue system, and they play a significant role in funding public services and welfare programs. But how do you calculate how much tax and NICs you owe? And what are the different rates and thresholds that apply?
In this post, we demystify the process of tax and National Insurance calculations and provide you with the knowledge you need to confidently navigate these financial obligations.
The Fundamentals of UK Tax and National Insurance Contributions
Tax and National Insurance are both compulsory levies all UK residents must pay to the government. However, they serve different purposes. Tax is levied on your income, while National Insurance Contributions (NICs) go towards funding state benefits, such as the National Health Service (NHS) and the state pension scheme. Although there are many nuances between each plan, we’ll attempt a summary breakdown of both.
Types of Taxes
There are several types of taxes in the UK. The main ones being income tax, capital gains tax, inheritance tax, and value-added tax (VAT). For today’s topic, our focus will be on Income tax – the most essential form of tax in the UK, which contributes over 9% of the national income.
Income tax is money paid on your income from various sources, such as employment, entrepreneurial endeavours, pensions, savings, dividends, and property. However, you do not pay income tax on all your income but only on the amount exceeding your personal allowance.
What’s a personal allowance, you say? This is the amount of income you are allowed to earn before your income becomes tax-deductible. For the current tax year, i.e., from 6 April 2023 to 5 April 2024, the personal allowance stands at £12,570; this means if your total income is less than or equal to £12,570, you do not have to pay any income tax.
Calculating Income Tax
Calculating your income tax requires you to determine your taxable income and apply the appropriate tax rates and allowances. Once you have calculated your taxable income, you can deduct any allowable expenses and apply tax reliefs to reduce your tax liability.
The level of income tax you are required to pay is determined by the portion of your income that falls into each tax band. These tax bands are of three main categories; basic rate, higher rate and additional rate. The basic rate applies to income above your personal allowance up to £50,270. The higher rate applies to income above £50,270 up to £150,000. And the additional rate applies to income above £150,000. The table below shows the income tax rates and bands for the current tax year.
Tax Band
Taxable Income
Tax Rate
Personal Allowance
£0 to £12,571
0%
Basic Rate
Between £12,571 and £50,270
20%
Higher Rate
Between £50,271 and £150,000
40%
Additional Rate
Over £150,000
45%
So, suppose your total annual income is £60,000. Your taxable income falls into the basic and higher rate tax band. Therefore, you would calculate your annual tax as follows:
- You pay no income tax on first £12,570 that you make
- You pay 20% on the next £37,700 at basic income tax rate = £7,540
- You pay 40% on the next £9,730 at higher income tax rate = £3,892
Your total income tax liability for the year = £11,432
National Insurance Contributions
National Insurance is a social security system that provides individuals access to various state benefits, such as the state pension, unemployment benefits, and maternity pay. Similar to tax deductions, the amount of National Insurance you pay is determined by your earnings and your employment status.
You’re obligated to pay this levy if you’re an employee earning above £242 a week or self-employed and making a profit of £6,515 or more a year. However, unlike income tax, you stop paying national insurance when you reach the state pension age of 66.
There are different classes of National Insurance contributions, each with its own rates and thresholds. These classes include:
- Class 1: for employees earning above £242 a week and under state pension age.
- Class 2: for self-employed people making a profit between £242 and £967 or more per week.
- Class 3: voluntary contributions to fill or avoid gaps in your national insurance record.
- Class 4: for self-employed people making a profit of £12,570 or more a year
Calculating National Insurance Contributions
Suppose you’re an employee; your employer automatically deducts Class 1 contributions under the PAYE (Pay As You Earn) system. For the 2023/2024 tax year, you pay 12% of your weekly earnings between £242 and £967 and 2% of your weekly earnings above £967.
Say you earn £2,000 a week; calculating your insurance contributions goes something like this:
- You pay nothing for the first £242
- 12% (£87) on the next £725
- 2% (£20.66) on the remainder £1,033.
Therefore, your total payable insurance contribution = £87 + £20.66; that comes to £107.66
If you are self-employed, you may need to pay both Class 2 and Class 4 National Insurance contributions. Class 2 contribution is a flat fee of £3.45 payable if your profits exceed a certain threshold, while Class 4 contributions are based on your profits above a certain threshold. As a self-employed individual, it is important to keep accurate records of your income and expenses to ensure that you are paying the correct amount of National Insurance.
Conclusion
We’ve explained the basics of taxes and NICs in the UK and provided a step-by-step guide on how to calculate them for the current tax year. If you require an in-depth assessment of how much income tax and NICs will be deducted from your salary per week, month and year, you can seek the assistance of a qualified tax professional. Do you reside in Surrey? Sloane Winckless are chartered accountants Epsom and Ewell Towns have trusted for over 35 years, so don’t hesitate to reach out.
