How income tax is calculated
When HMRC calculates how much tax you need to pay, it looks at your non-savings income first, followed by your savings income, and then your dividend income.
So, if you're working out the sums for yourself, it makes sense to follow this pattern.
As a first step, you should work out your non-savings income - that's your income and earnings, excluding any savings interest or dividends
- Get a head start on your 2020-21 tax return with the Which? tax calculator. Tot up your tax bill, get tips on where to save and submit your return direct to HMRC with Which?.
Calculate your non-savings income
To work out your non-savings income, follow the steps below.
1. Work out your taxable income
Don't include income from savings and investments at this stage, as they are taken into account later.
Add all of this income together to find your total non-savings income.
But you won't owe tax on all of this. In the 2021-22 tax year, the first £37,700 above your personal allowance of £12,570 (so, up to total earnings of £50,270) will be taxed at 20%, which is the UK basic tax rate.
Anything you earn above this amount will be taxed at 40%. If your income exceeds £150,000, you'll be taxed at 45% on anything over this threshold.
In Scotland, income tax rates and thresholds are different - find out what you'll pay in our guide on income taxes in Scotland.
2. Deduct tax reliefs
Tax reliefs can be claimed to reduce your overall bill. These can include:
- Pension contributions made through your employer's pension scheme, (but not any contributions made to personal or stakeholder schemes, as relief for these contributions is given later in the income tax calculation)
- Qualifying loan interest payments.
- Qualifying gifts to charities.
3. Deduct allowances.
A tax-free allowance refers to the amount of money you're able to earn before paying tax.
In addition to the personal allowance, mentioned above, you may also be able to claim the following allowances:
- Blind person’s allowance
- Marriage allowance
- Trading allowance
- Property allowance
Find out more: Tax-free income and allowances
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, and 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
Note down 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 2021-22 personal allowance of £12,570 can use up the full £5,000 savings starter rate.
For each pound you earn over the personal allowance, the same amount is taken off the savings starter rate – so, if you earn £13,570, you’d only have a £4,000 savings starter rate. If you earn more than £17,570, you won’t have any savings starter rate at all.
3. Deduct your personal savings allowance
Your personal savings allowance is separate – and in addition - to the savings starter rate. In 2021-22, 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.
4. Pay tax on remaining interest
Once you've deducted the personal savings allowance (and the starter savings rate, if applicable) 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.
Find out more: Tax on savings - more on how the personal savings allowance works.
Tax on your dividend income
The first £2,000 you receive in dividend from investments is tax-free in the 2020-21 tax year - known as your dividend allowance. This was the same in 2019-20.
Any earnings above this threshold differently according to your normal tax rate. Basic-rate taxpayers will pay 7.5% tax on dividends, higher rate taxpayers 32.5%, and additional rate taxpayers 38.1%.