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Ask an expert: ‘Do I pay more tax than someone who has a bigger income than me?’

How to calculate your 'marginal' tax rate

Ask an expert: ‘Do I pay more tax than someone who has a bigger income than me?’

Every week, Which?’s money experts answer your financial queries. You can submit your questions to money-letters@which.co.uk, or via our Facebook or Twitter pages.

Q.  I read in the press this week that, on a £60,000 a year salary, I could be paying tax at 60%, despite the fact that I thought I was a 40% taxpayer. The article I read said I could be paying more tax than someone earning £1m. How is this possible?’

Submitted via email.

A. This is a curious and under-appreciated quirk of the UK’s complex tax system, whereby a succession of changes to tax allowances and reliefs over the years, applied to certain groups people on a range of incomes, could leave you paying a much higher ‘marginal’ rate of tax.

The coverage you’ve read stems from some research carried out by insurance company Royal London. It found that 775,000 people currently pay a higher tax rate on each extra pound they earn over a certain amount than a millionaire.

And, depending on your personal situation, its research suggests that someone with your level income could have a tax rate as high as 60%.

So, how does this work? First, it’s important to understand how income tax is deducted from your earnings.

For people earning less than £100,000, the first £11,500 you earn is tax free. The next £33,500 is taxed at 20% (the basic rate). Earnings above £45,000 are taxed at 40%, and income above £150,000 is taxed at 45%.

But these are only income tax rates. You also pay National Insurance contributions (if you’re under state pension age). The rates differ depending on your income and employment status

Employees of a company pay National Insurance at 12% on earnings between £8,164 and £45,000, and 2%  on anything above that amount. The self-employed pay a slightly lower rate of 9% on the lower threshold and the same 2% rate on anything above £45,000.

So, if you’re an employee earning £60,000, you’ll pay:

  • 20% income tax on £33,500 = £6,700
  • 40% income tax on £15,000 = £6,000
  • 12% National Insurance on £36,836 = £4,420
  • 2% National Insurance on £15,000 = £300

The total tax you pay is £17,430, which is 29% of your income.

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When lower earners end up with higher tax rates

Royal London identified three groups of people that could end up paying significantly more tax for every extra pound they earned. This is because valuable tax-free allowances or benefits are reduced to the amount of income they earn.

Parents earning more than £50,000

Since 2013, couples with children with one partner earning more than £50,000 see the child benefit they can claim reduced by £1 for every £100 they earn of their amount.

A couple with two children would ordinarily get £1,789 in child benefit for a year. The table below shows child benefit rates for this tax year.

Child benefit rates 2017-18
Children Child benefit (per week) Child benefit (per year)
1 £20.70 £1,076.40
2 £34.40 £1,788.80
3 £48.10 £2,501.20
4 £61.80 £3,213.60
5 £75.50 £3,926.00

But if one person in that couple earned £51,000, the additional £1,000 would have £400 in income tax deducted, £20 in National Insurance and would lose £179 in child benefit, totalling £599.

That means their marginal tax rate in the extra income they earned would be 59.9%. It’s estimated that 375,000 are affected by this.

People who earn between £100,000 and £123,000

Once you earn more than £100,000 a year, your tax-free personal allowance (currently £11,500) starts to reduce by £1 for every £2 you earn over that amount. By the time you reach £123,000, you lose your personal allowance altogether.

Royal London found that someone earning £101,000 loses £500 in personal allowance, which is subsequently taxed at 40% resulting in an additional £200 income tax to pay. That’s added to the £400 in income tax they pay on the extra £1,000 and £20 they pay in National Insurance, totalling £620, or 62% on the extra income they’ve earned.

Around a quarter of a million people are taxed in this way.

Those earning up to £210,000 a year (inclusive of employer pension contributions)

If you earn less than £150,000, you can contribute up to £40,000 into a pension. This is your ‘annual allowance’. This has reduced significantly over the years, as our interactive chart below shows.

Above £150,000, the amount you can contribute to earn tax relief falls, reducing at a rate of £1 for every £2 you earn above that amount. By the time you reach £210,000 you can contribute a maximum of £10,000.

For every extra pound you earn over £150,000, you pay a tax rate of almost 70%, made up of 45% income tax, 22.5% from the reduction in your annual allowance and 2% in National Insurance. Royal London estimates that ‘around 150,000 people may be affected’ by this.

Steve Webb, former government minister and now director of policy at Royal London, has called on the Chancellor to use the upcoming Budget (on 22 November) ‘to rationalise the tax system so that is simpler, fairer and easier to understand.’

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