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The personal taxes draining your income – how to make sure you don’t overpay
Telegraph Money explains the different taxes and ways to reduce your tax bill
Households are paying record levels of tax to HMRC as frozen thresholds continue to leave individuals with higher bills.
HMRC’s tax-take hit a record £786.6bn in the 2022-23 tax year and the current financial year is set to be just as rewarding for the taxman. Hard-working Brits paid £70.9bn to HMRC in April 2023 alone – an increase of £1.8bn compared to April 2022.
Tax thresholds are set to remain the same until 2028, meaning that as wages rise, increasing numbers of people will end up in higher tax brackets – a process known as “fiscal drag”.
The only light at the end of the tunnel comes in the form of some forthcoming National Insurance rate cuts; employees saw Class 1 rates fall from 12pc to 10pc at the start of this year, and there’s more to come in April as Chancellor Jeremy Hunt announced Class 1 and Class 4 rates will fall to 8pc and 6pc respectively.
Here, Telegraph Money outlines the main personal taxes to be aware of – and some of the reliefs that could reduce your tax bill. This guide will cover:
Income tax
The biggest chunk of your tax bill – and HMRC’s largest source of revenue – comes from income tax, which is taken from your earnings. This includes everything from your wages and rental income, to savings interest and money you withdraw from your pension.
The more you earn, the more income tax you will pay.
The majority of people won’t pay tax on their whole income; the personal allowance, currently worth £12,570, is the tax-free portion of your income before any tax is charged.
However, those who earn more than £100,000 pay tax on a larger proportion of their earnings; the personal allowance reduces by £1 for every £2 earned over £100,000, so that by the time you earn £125,140 you’ll have no tax-free personal allowance.
The rate you pay on income over this amount will depend on if you are a basic, higher or additional-rate taxpayer.
As of the 2023-24 tax year, the thresholds in England, Northern Ireland and Wales are:
Income tax in Scotland has different tax bands and rates, as below:
Employees will have the money taken through the Pay As You Earn (PAYE) system each month from their payslip. The amount of tax you’re paying is indicated by your tax code, and it’s worth checking to see whether you’re paying the right amount.
Self-employed workers have to declare their earnings and pay any tax owed via a self-assessment tax return, due by January 31 following the end of the tax year.
If you’re employed but have multiple income streams, you’ll also need to complete a tax return – such as if you receive rental income.
National Insurance
National Insurance contributions (NICs) build your own entitlement for benefits such as the state pension, as well as maternity allowance, bereavement support payment and new-style jobseeker’s allowance.
You will need to pay if you are over 16 and earning more than £12,570 a year.
NICs are divided into four classes:
• Class 1 (employees): 10pc on earnings between £12,570 and £50,270, and 2pc on earnings above £50,270. From April 6 2024, the rate will fall to 8pc.
• Class 2 (self-employed): £3.45 per week if profits are £12,570 or more per year. From April 2024, this form of NI will be abolished – but those who would usually have paid it will still accrue NI contributions.
• Class 3 (voluntary): £17.45 per week
• Class 4 (self-employed): 9pc on profits between £12,570 and £50,270, and 2pc on profits above £50,270. From April 2024, the rate will fall to 6pc.
Similar to income tax, the money is taken from your payslip through PAYE if you are employed, or via self-assessment if you work for yourself or need to declare additional forms of income.
VAT
The government also takes a cut on your shopping through a consumption charge known as Value Added Tax (VAT).
This is built into the price when you buy most goods and services, such as a TV or clothes.
The main VAT rate is 20pc, but there are exemptions for items such as children’s clothing, and there is a lower 5pc rate for energy bills and some goods including child car seats.
There are some quirks to the system. For example, the full 20pc rate is charged on biscuits, but cakes are exempt.
If you have your own business, you must register for VAT if you have an annual turnover of more than £85,000 – you can also register voluntarily if your turnover is less than this.
From April 1, this threshold will rise to £90,000.
Once you’re registered, you must add VAT to sales invoices. Traders usually offset the VAT charged by their suppliers against the VAT charged to customers via their VAT return.
Capital gains tax
There may be capital gains tax (CGT) to pay if you make a profit from selling a valuable asset, such as a second home, shares or other possessions.
Everyone gets a tax-free CGT allowance, which is £6,000 in 2023-24 – reduced from £12,300 in the previous tax year. The allowance is set to reduce to £3,000 from April 2024.
The amount you pay depends on your income and what you are selling.
If you’re not selling property, basic-rate taxpayers pay 10pc CGT, rising to 20pc if you’re a higher-rate or additional-rate taxpayer.
Profit made from selling a property that isn’t your main residence is taxed at 18pc if you pay basic-rate tax, or 28pc if you pay a higher rate. From April 6, this higher rate will be reduced to 24pc, in a move the Chancellor hopes will boost property sales.
While profits made from selling other assets can be included as part of a self-assessment tax return, gains from residential property sales must be reported via a UK property return and tax must be paid within 60 days of selling the property – in addition to detailing the sale in a tax return.
Dividend tax
You may receive dividend payments if you hold company shares.
You can earn up to £1,000 tax-free in 2023-24, but this will drop to £500 from April.
Above this, dividend tax is charged at 8.75pc for basic rate taxpayers, 33.75pc for higher rate taxpayers and 39.35pc for those on the additional rate.
If you earn more than £10,000 in dividends you’ll have to pay the tax you owe via a self-assessment tax return. If you earn less, you may be able to pay the extra tax you owe with a change to your PAYE tax code – but you’ll need to request HMRC to do this.
Inheritance tax
While you won’t technically be the person paying inheritance tax (IHT) on your own money, inheritance tax is a charge your estate – or heirs – could pay on the value of your assets when you pass away, including property, money and possessions.
There is a tax-free allowance of £325,000, known as the nil-rate band. You can also pass on a further £175,000 without tax if you’re passing your main residence to a direct descendant.
Couples can pool their allowances, so up to £1m can be passed to their heirs without paying any IHT.
If your estate is valued above this threshold, it will be taxed at a rate of 40pc.
The nil-rate band has been the same since 2009, which critics deem unfair as an increasing number of estates are triggering IHT bills, due to rising house prices pushing beyond the allowance.
Any inheritance tax owed will need to be calculated and paid to HMRC by appointed executors within six months of the date the person died.
Tax reliefs
Tax reliefs enable you to deduct some of the payments you make from your gross income, reducing the amount that’s left to pay tax on.
You receive tax relief on pension payments. If you pay into an employer pension scheme, your contribution is usually taken before tax is calculated, meaning you’ll have less of an income to be taxed on. Other salary sacrifice schemes work in the same way, such as the cycle to work scheme.
If you have a personal or stakeholder pension, your provider will claim back the tax you’ve already paid on the money you deposit.
For example, if you’re a basic-rate taxpayer and deposit £100 into a personal pension, your pension provider will claim £25 back from HMRC – as you’ll have paid 20pc income tax on this amount.
If you’re a higher-rate taxpayer, you’ll need to claim tax relief for the extra 20pc via a self-assessment tax return.
You may also find it beneficial to invest in risky start-up businesses, through the Enterprise Investment Scheme (EIS). This Government-backed scheme has the potential to cut up to £300,000 from your tax bill – but due to the risk involved, these kinds of investments should only make up a small part of your portfolio.
It can also be worth making certain charitable donations, as some qualify for income tax relief on the full market value of the gifts. These include units in authorised unit trusts, listed shares and securities and shares in open-ended investment companies (OEICs).
In some instances, working from home can also reduce your tax bill – you could save up to £300 if you don’t work in the office.
Finally, you can also get tax relief on the interest you pay on certain loans, such as if you’ve taken out a loan to pay IHT, loans to make investments in certain types of partnerships and loans taken out to purchase shares in your company (provided it’s not an investment company).