25 Feb
Income Tax and National Insurance (NI) Basics
Income Tax and NI basics for beginners
Income-tax in the UK is levied on several types of earnings. These can range from employment wages, profits from running a business, rental income from property, dividends from shares, etc.
Related: You might want to read our guide to renting out as a landlord.
In certain cases, you don’t have to pay taxes on your entire taxable income. Most of the tax-paying individuals in the UK qualify for a Personal Allowance. This gives individuals a significant tax break by reducing the amount of taxable income. Anyone can qualify for a Personal Allowance, including students. The sum can vary depending on your tax history and the allowances claimed. The details regarding Personal Allowance are explained below in more detail:
Related: Want to learn more about tax on your pension income? Read more on our blog.
What do you need to know about personal allowance?
As mentioned above, the personal allowance is the amount of income that an individual can enjoy tax-free. Personal allowance may vary from individual to individual. For example, the personal allowance may be greater if a person has either claimed a marriage allowance or a blind person’s allowance. Some individuals can be qualified for a lesser amount due to taxes they might owe for previous years.
The standard personal allowance is £12,500 and will continue to be the same for the tax year 2020/21. If your income falls below the standard personal allowance, you will not be liable to pay any income tax.
Note: Your personal allowance will be deducted from your income before you pay your income tax.
Summary of allowances for the year 2019-2020:
What about your personal allowance if you earn over £100, 000?
For individuals earning more than £100, 000, with an allowance of £12,500 there will be a deduction of £1 for every £2 you earn. If you earn £125, 000, there will be no tax-free allowance, and you will have to pay income tax on the entire amount you earn.
How is the amount of income tax determined?
Generally speaking, the amount of income tax you are liable to pay depends on two factors:
- The amount of income that falls within each tax band.
- The amount of income that falls above your personal allowance.
Remember that the tax year begins from 6th April and ends on 5th April the following year.
You may want to speak to a tax accountant to help you calculate the accurate amount of income tax you owe to HMRC.
What is the amount of income tax you are liable to pay?
The amount of income tax you pay is subject to different bands. This implies that the more you earn, the more income tax you have to pay. The reason behind the proportionality is to encourage people to contribute a higher portion of their earnings to the Government’s treasury in taxes if they earn higher.
The table below reveals the income tax rate for the tax year 2019-20 that you are liable to pay depending on how much you earn:
For 2019/2020:
| Taxable income | Band | Tax rate (%) |
| Up to £12,500 | Personal allowance | 0 |
| £12,501- £50,000 | Basic rate | 20 |
| £50,001- £150,000 | Higher rate | 40 |
| £150,001 and above | Additional rate | 45 |
An erroneous calculation of the income tax is a common problem faced by many individuals in the UK. It is therefore advisable to speak to our in-house tax accountants, before calculating your income tax and filing your annual tax returns.
What is the purpose of income-tax collection?
The collection of the income-tax collection lies with Her Majesty’s Revenue and Collections department, in tax year 18-19 alone HMRC collected £ 627.9 Billion in tax revenues up 3.6% to the previous year. The income-tax collected is reinvested in the public service sector. It is used to improve public projects like infrastructure development, real estate, railways, public parks, etc.
National Insurance
What do you need to know about National Insurance (NI) on employment income?
National Insurance contributions are tax payments that are meant to be made from your income. These tax payments make you eligible to enjoy specific benefits like the State Pension and Maternity Allowance. You are not required to pay NI annually, but you will be required to make NI contributions according to your employer’s arrangement.
These can be monthly, weekly or quarterly installments – depending on the employee’s contract. This implies that if you earn more than the regular income amounts, you will be liable to make extra NI contributions. Also, once you pay that extra income as NI contribution, you can not claim that amount back even if you earn less during the other periods of the tax year.
According to the 2019-20 rules, you have to pay National Insurance once you start earning more than £166 per week. The rate of National Insurance you are liable to pay depends on your earnings:
- For weekly earnings between £166 – £962=12%
- For weekly earnings above £962 = 2%
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What do you pay National Insurance on?
You and your employer are legally required to pay NI contributions on your income, be it sick leave pay, holiday pay or maternity leave pay. Usually, they are paid on any benefit or reward that is highly liquid. There are some flexibilities to this rule, you might be exempted if a portion of your income is in the form of shares in the company you are employed with, this can be achieved with the help of tax-approved share schemes.
In case you are entitled to certain benefits, you as an employee are not liable to make NI contributions. However, there are also exceptions to this rule where employers are required to pay NI on the monetary value of any benefits that you are entitled to enjoy.
What does your National Insurance cover?
Paying for National Insurance helps you enjoy various state benefits and services, which include:
- The State Pension.
- Unemployment benefits.
- The National Health Service (NHS).
- Sickness and disability allowances.
What do you need to know about Voluntary ‘Class 3’ National Insurance rates?
The purpose of Class 3 voluntary National Insurance Contributions is to help you get a higher State Pension by filling any gaps in your National Insurance record. You may receive a full new State Pension once you reach the State Pension age or if you have 35 qualifying years of National Insurance contributions. If you have less than 35 qualifying years of National Insurance Contributions, then you may receive a reduced State pension. A minimum of 10 qualifying years of NI contributions is required to receive the new State Pension.
We advise you to pay Class 3 voluntary contributions to increase your pension entitlement. From 2019-20, you can pay Class 3 contributions at a rate of £ 15 per week (maximum amount payable per week).
What do you need to know about Voluntary ‘Class 2’ National insurance rates?
Voluntary Class 2 NI contributions can be made if you are running your own business, working as a self-employed individual or have been working in a foreign country.
For 2019-20 you have to make weekly Class 2 NI contributions at a flat rate of 3 per week If you earn £6,365 (the small profits threshold) or more as profits in the year 2019-2020.
Making Class 2 NI contributions is completely optional for any self-employed individual, making profits lower than the small profit threshold. However, we advise you to pay Class 2 NI even if you are below the small profit threshold to increase your entitlements to state benefits.
What do you need to know about Voluntary ‘Class 4’ National Insurance rates?
If your profits as a self-employed individual are £ 8,632 or more you need to pay class 4 NI, this is payable at 9% on profits above £ 8,632 and up to £ 50,000; and 2% on profits above £ 50,000.
Related: Learn how you can make tax-free income on top of your taxable income by reading our blog
Clear House Accountants are expert Accountants in London who specialize in helping clients with their tax requirements. Our personal tax accountants have been trained to find bespoke solutions to help them save tax and increase their cash flow.
Author Bio
Jinesh is a Senior Business Accountant, with a masters in Finance from Westminster University, and specializes in tax and accounting for small to medium businesses with a turnover less than £ 3 Million.
He specialises in helping creative businesses understand and manage their accounting and tax needs and obligations.
As accounting ecosystems evolve, their potential to add value also grows. This has increased the focus on digital solutions to tackle complex business problems. Jinesh helps businesses see the opportunity in this and helps businesses become more efficient and increase performance, using the right solutions.
Some of the key things he focuses on are:
- Helping businesses gain insights from their business data
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- Helping businesses prepare for complex industry developments and changes