How tax is calculated in the UK

How to work out how much tax you'll pay after your tax-free allowances

HMRC calculates how much tax you need to pay by initially looking at your non-savings income. Then at your savings income, and then at your dividend income. So, if you are working the figures out yourself, it makes sense to use this same structure.

Start by working out your non-savings income. This is your income and your earnings, excluding any savings interest or dividends.

Calculate your non-savings income

1. Work out your taxable income

Add together your non-savings income. This could include self-employment, freelance work, pensions, rental income and taxable state benefits. Don't include income from savings and investments at this stage. These will be added later. Add these figures together to find out your total non-savings income.

But you won't owe tax on the total of this amount. In the 2020/21 tax year, the first £37,500 above your personal allowance (up to total earnings of £50,000) is taxed at 20%, which is the UK basic tax rate. Anything you earn above this amount is taxed at 40%. If your income exceeds £150,000, you'll be taxed at 45% on anything over this threshold.

2. Deduct tax reliefs

Tax reliefs can be claimed to reduce your overall tax bill. These can include:

- Pension contributions made through your employer's pension scheme

- Qualifying loan interest payments.

- Qualifying gifts to charities.

3. Deduct allowances

'Tax-free allowance' refers to the amount of money you're allowed to earn before paying tax on it. In addition to this personal allowance, you may also be able to claim the following:

- Blind person’s allowance

- Marriage allowance

- Trading allowance

- Property allowance

4. Calculate how much tax you'll pay

The figure you're left with after these deductions is the non-savings part of your income that you’ll pay tax on.

Tax on your savings income

When you earn interest on your savings, this interest will be treated as income, and is liable for tax. This could include interest earned from:

- bank and building society accounts

- savings and credit union accounts

- unit trusts

- investment trusts and open-ended investment companies

- peer-to-peer lending

There are a few steps to finding out how much tax you’ll pay on your savings.

1. Find out how much you earned in interest

Make a note of how much you earned from your savings for the year. You can find this out from a statement from your bank or building society.

2. Work out if the starter savings rate applies

The savings starter rate is £5,000 of tax-free savings income in addition to your personal allowance. Those who earn below the 2020/21 personal allowance of £12,500 can use up the full £5,000 savings starter rate. For each pound you earn over the personal allowance, the same amount is removed from the savings starter rate. So if you earn £13,500, you’d only have a £4,000 savings starter rate. If you earn more than £17,500, you won’t have any savings starter rate at all.

3. Deduct your personal savings allowance

Your personal savings allowance is separate to the savings starter rate. In 2020/21, basic rate taxpayers can earn up to £1,000 from savings tax-free. Higher rate tax payers can earn up to £500; and additional rate tax payers do not receive a savings allowance. This is unchanged from 2019-20.

4. Pay tax on remaining interest

Once you've deducted the personal savings allowance from your total savings interest, you'll be left with your total taxable savings income. This will be added to your total income, and you'll pay income tax according to your band.

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