Income tax explained
Here we cover the basics of income tax and how tax might be paid on your pension income or savings interest.
Income tax is collected by HM Revenue & Customs (HMRC) on behalf of the government and is used towards funding public services and education as well as investing in road repairs and housing.
The tax you are charged depends on the amount of income you receive. The salary from your job, profits from your business, pensions and rent received if you’re a landlord are just a few income examples.
There are allowances which mean you don’t usually pay income tax on all your taxable income.
The personal allowance is an amount of money you are allowed to earn before you start paying income tax which is reviewed every tax year and is subject to change. If you earn less than the personal allowance limit, you shouldn’t need to pay any income tax.
Let’s look at a simple example based on the 2021/2022 tax year rates and allowances. Income tax bands and rates are different if you live in Scotland.
Tax band for 2021/2022
Up to £12,570
Between £12,270 and £50,270
Between £50,271 and £150,000
Let’s look at an example. Jo earns £34,800 and has no savings interest or other income.
The personal allowance means that no tax will be payable on the first £12,570, but will be payable on anything over that amount which is £22,300.
As Jo doesn’t earn over £50,270 – the top end of basic rate tax band – tax will be payable at the basic rate of 20% on £22,300. This means Jo pays £4,460 in tax on this income.
If you earn over £100,000 in a year your personal allowance is reduced by £1 for every £2 you have earned above £100,000. If you earn over £125,000 in a year then income tax is paid on all of your income and there is no personal allowance.
For more information on what income tax you may need to pay take a look at our Tax Year Rates and Allowances booklet
Now we’ve covered the basics, let’s look at pensions and tax.
Most people can earn some interest from their savings without paying tax.