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Explained: Paying Tax and Tax Codes

This guide is NOT written as advice but rather as an understanding of how tax works.  If you are worried about tax at all you should speak to your employer’s payroll or HR team, or seek professional advice.

Tax is not taught in schools (or at least it wasn’t for us) but it’s something everyone will encounter in the world of work.  In a previous guide, we have discussed the payslip in general (see this here >), but we get a lot of questions about how tax works and why you have to pay it, or why it’s increased or decreased.

It’s easy to fixate on certain parts of the payslip…most notably the amount that will appear in your bank.  However, it’s really important to understand how tax works too.  This guide is going to focus on tax, not National Insurance (NI).

In summary, everyone pays a percentage of their taxable income as tax.

We use the term taxable income because not all money paid to you is taxable.  This includes expenses, child support payments and gifts.

The percentage of tax you pay depends on the tax bracket you fit into.  The tax bracket means low earners may not pay any tax and high earners will pay more.

These are the tax brackets for the 2018/19 tax year…

Taxable Income Tax Rate (Band) Tax Rate
Up to £11,850 Personal allowance 0%
£11,851 to £46,350 Basic rate 20%
£46,351 to £150,000 Higher rate 40%
Over £150,000 Additional rate 45%

In the table above, the first band, ‘Up to £11,850’ is the tax-free allowance that is determined by your tax code.  Most people have the same tax code, which in 2018/19 is 1185L.  These are normally sent out automatically and electronically to employers by Her Majesty’s Revenue and Customs, or HMRC.

This code tells an employer, and you, that you get (roughly) £1,185 multiplied by 10 = £11,850 tax-free every year.

An employer should take this amount, divided by the number of times you get paid a year and minus it off your salary.  What remains is taxable and is subject to the above rates of tax (20%, 40% and 45%).  The HMRC have complete control over this and can fine companies that don’t follow their instructions correctly.

 

Examples

Let us do a couple of examples to make it easier to understand.  In each example the tax code is 1185L, meaning the tax-free allowance will be £11,850 per year, £987.50 per month or £227.88 per week.

When looking at the examples, the taxable income is the gross pay minus the tax-free allowance, this is what you are then taxed on.

Example 1:

Your salary is £18,500 per year.  You have no student loan, and are not yet enrolled in a company pension.

Yearly Monthly Weekly
Gross Pay £18,500.00 £1,541.67 £355.77
Taxable Income £6,650.00 £554.17 £127.88
Tax at 20% £1,330.00 £110.83 £25.58
NI £1,209.12 £100.76 £23.25
Take Home £15,960.88 £1,330.07 £306.94

Example 3:

Your salary is £65,500 per year.  You have no student loan and are paying 12% into a company pension.

Yearly Monthly Weekly
Gross Pay £65,500.00 £5,458.33 £1,259.62
Pension Deductions £4,838.16 £403.18 £93.04
Taxable Income £48,811.84 £4,067.65 £938.69
Tax at 20% £6,900.00 £575.00 £132.69
Tax at 40% £5,724.74 £477.06 £110.09
NI £4,934.12 £411.18 £94.89
Take Home £43,102.98 £3,591.92 £828.90

Example 2:

Your salary is £35,000 per year.  You have a student loan repaying using plan 2, and are paying 5% into a company pension.  A pension deduction is usually taken from your gross pay.  This means that it comes off your pay BEFORE the tax is calculated.  So you don’t pay tax on pension payments, hence below the taxable income is minus the tax-free allowance and the pension deduction.

Yearly Monthly Weekly
Gross Pay £35,000.00 £2,916.67 £673.08
Pension Deductions £1,448.40 £120.70 £27.85
Taxable Income £21,701.60 £1,808.47 £417.34
Tax at 20% £4,340.32 £361.69 £83.47
NI £3,189.12 £265.76 £51.33
Student Loan £900.00 £75.00 £17.31
Take Home £25,122.16 £2,093.51 £483.12

In the above examples, you can see that certain things affect your take-home pay.  Student loans and pensions being the main ones to consider here.  The third example above has quite a large salary, we’ve included it to illustrate how the tax brackets interact with each other.

Essentially, when you go outside a bracket you must start paying the remainder at the next percentage up.  But don’t worry, you are not paying more tax than you should.

A great website to use to check your pay, or to try out a few different salaries to see how it all works is The Salary Calculator.

If you are worried about your tax, the best place to go for help is your employer.  They should be able to go through a few bits with you, however, if your query is tax code related it is more than likely that HMRC has requested a code change.  Your employer will not know the reason for this as HMRC don’t give reasons on the notifications that come through.  In this case, if you want more information you will need to contact HMRC directly and ask them about the tax code.

We hope this has helped you understand your tax a little bit better.  Check out the rest of the Advice Hub for more great guides on all aspects of getting new roles, interviews, CV help and a lot more.

We’ll be launching more tax-related guides soon, including further information on forms and refunds.  So, keep an eye out on social media in the next couple of weeks.

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