The amount you can earn tax-free will increase from today, the start of the 2020-21 tax year – but other tax changes may mean the ‘pay rise’ is short-lived.
The government announced a raft of changes in the recent Budget, some of which could increase your income and some of which may reduce the amount of money you take home.
Here, Which? explains how to use all tax-free allowances to your advantage, from benefiting from the rent-a-room scheme to reducing the tax you pay on your savings.
Maximise your tax-free earnings
Every year, you’re allowed to earn a certain amount from various sources of income before being required to pay tax. This is your tax-free allowance.
It’s not just about the money you earn from your main employment, either – there are also taxes to be paid on savings interest, dividend income from shares and capital gains when you make a profit from selling a valuable item, and each type of income has its own tax rate and allowance.
Click on the links below to find out more about each kind of tax:
- £12,500 employment income
- £2,000 dividend allowance
- £6,000 savings interest
- £1,250 marriage allowance
In addition to this, if you buy, rent or sell things you own, you could qualify for several other allowances:
- £12,300 capital gains allowance
- £1,000 trading allowance
- £1,000 property allowance
- 7,500 rent-a-room scheme
Personal allowance remains at £12,500
The personal allowance is the amount you can earn from your salary – whether you’re employed or self-employed – each tax year, before income tax kicks in.
For 2020-21, the personal allowance is sticking at £12,500, so if you earn less than this, you won’t need to pay any income tax.
The graph below shows how the personal allowance threshold has changed over the past few years.
Income tax when you earn more than the personal allowance
If you earn more than the personal allowance, you’ll be charged tax on your income.
England, Wales and Northern Ireland have the same three income tax bands:
- 20% basic rate: £12,501-£50,000
- 40% higher rate: £50,001-£150,000
- 45% additional rate: £150,001+
Income tax in Scotland is slightly different, where the following bands and thresholds apply:
- 19% starter rate: £12,501-£14,585
- 20% basic rate: £14,585-£25,158
- 21% intermediate rate: £25,158-£43,430
- 41% higher rate: £43,430-£150,000
- 46% top rate: £150,001+
Anyone in the UK with earnings more than £100,000 will start to lose their personal allowance; for every £2 over the £100,000 threshold, you’ll lose £2 of your personal allowance.
This means that anyone who earns more than £125,000 will be taxed on all of their income.
- Find out more: tax-free income and allowances
National Insurance thresholds have risen
National Insurance is another bill that’s taken out of your salary, but the rates and thresholds are different to income tax – although the government is planning to gradually make them the same.
What and how you pay differs for employed and self-employed workers.
In 2020-21, employed workers will pay Class 1 contributions of 12% on earnings between £9,500 and £50,000. This is up from £8,632 in 2019-20. Earnings above £50,000 are taxed at 2%, which is unchanged.
Self-employed workers may need to pay Class 2 and possibly Class 4 contributions on their profits. Class 2 is a payment of £3.05 a week (up from £3 a week) for profits between £6,475-£9,500. In 2019-20, this threshold was £6,365-£8,632.
You’ll pay Class 4 of 9% if your profits are between £9,500-£50,000 – in addition to Class 2. The rate is 2% for profits of more than £50,000.
- Find out more: National Insurance rates
Dividend allowance remains at £2,000
The tax-free amount you can earn from dividends in 2020-21 is £2,000 – this was the same in 2019-20.
You might earn dividends as part of your income if you’ve invested in company shares; you’ll only be taxed if you earn more than £2,000 during this tax year.
The rate of tax you pay depends on your income tax band, as follows:
- Basic-rate taxpayers: 7.5%
- Higher-rate taxpayers: 32.5%
- Additional-rate taxpayers: 38.1%
To see how much dividend tax you can expect to pay, you can try our calculator below:
- Find out more: dividend tax explained
Capital gains allowance rises to £12,300
The capital gains allowance is the amount of profit you can earn from selling valuable items before having to pay tax on it.
This has risen to £12,300 for 2020-21, up from £12,000 in 2019-20.
The graph below shows how the capital gains allowance has changed over the past few years.
If you own assets jointly with your spouse, you can pool your allowances – so, together you’d have £24,600 for 2020-21.
If you exceed the allowance, the amount of tax you’ll pay depends on your income tax band and what you’ve sold – property is taxed differently, and at a higher rate.
For basic-rate taxpayers, you’ll pay 10% on assets and 18% on property. Higher and additional-rate taxpayers are charged 20% on assets and 28% on property.
Any losses you’ve made can be offset against your gains to reduce your tax bill.
- Find out more: capital gains tax allowances and rates
Changes from April 2020
As of this month, any tax you owe from selling a property must be paid within 30 days of the completion of the sale or disposal.
Rather than declaring the income on your next self-assessment tax return, you must now submit a residential property return and make a payment on account.
Additionally, this April sees a number of changes to private residence relief come into force.
Private residence relief – which can help reduce the amount of capital gains tax someone has to pay if they’ve been letting a property they once lived in – will now apply to the time you lived in the property plus the final nine months of ownership.
It previously covered the final 18 months of ownership.
Lettings relief is also being scaled back so that it is only applicable for people who were in shared occupancy with their tenant.
- Find out more: capital gains tax on property
Marriage allowance remains at £1,250
If you’re married or part of a civil partnership, you could benefit from the marriage allowance.
This tax break is for couples where one partner earns less than the personal allowance (£12,500), and the other is a basic-rate taxpayer earning between £12,500 and £50,000.
The marriage allowance means that the lower earner can transfer 10% of their personal allowance to their partner, meaning the higher earner’s personal allowance is effectively increased to £13,750.
This means they’ll be able to keep more of their salary before tax kicks in.
In real terms, the higher-earning partner could get an extra £250.
- Find out more: marriage allowance explained
Trading allowance of £1,000
If you earn a small amount of money from activities such as selling items on eBay, making things to sell on Etsy or perhaps doing odd jobs for websites such as TaskRabbit, the £1,000 trading allowance could be useful.
You won’t need to tell HMRC if this income remains below £1,000 – but if you earn more, you’ll have to declare it on a self-assessment tax return.
- Find out more: how to fill in a self-assessment tax return
Property allowance of £1,000
Similarly to the trading allowance, you can also earn up to £1,000 from your property without having to declare the income to HMRC.
This can be for things such as renting out your parking space or using your house or garden for photoshoots.
As the allowance is relatively low, it’s unlikely to cover much of what you’d earn from renting out a room. In this case, you’d be better off using the Rent-a-Room scheme.
£7,500 with the Rent-a-Room scheme
The Rent-a-Room scheme threshold is staying at £7,500 for 2020-21. This is the amount you can earn tax-free for the year from letting a room in your home.
This only applies to the property you live in, so any buy-to-let properties are excluded.
If your earnings exceed the threshold, you must submit a self-assessment tax return to declare the income.
- Find out more: Rent-a-room scheme – letting a room in your home
Get up to £6,000 tax-free interest on savings
Depending on how much you earn, you could earn up to £6,000 in savings interest before having to pay tax.
This is through combining the £5,000 savings starter rate with the £1,000 personal savings allowance – however, only those who earn less than the personal allowance can take full advantage of this tax break.
For each £1 you earn over the £12,500 personal allowance, the starter savings rate that you’re eligible for will reduce by £1. Therefore, anyone who earns more than £17,500 in 2020-21 won’t have any savings starter rate allowance left.
The £1,000 personal savings allowance is applicable to anyone who’s a basic-rate taxpayer – this tax year, that’s anyone who earns less than £50,000.
Higher-rate taxpayers get a personal savings allowance of £500, while those who pay additional-rate tax don’t get any.
- Find out more: personal savings allowance and tax on savings interest
Save more on tax by using an Isa
You can avoid paying tax on your savings interest altogether by saving into an Isa.
The Isa allowance is remaining at £20,000 for 2020-21 – this is the maximum amount you can pay into an Isa (or a mix of different types of Isas).
Whatever you pay into any kind of Isa during the tax year will be taken out of your overall Isa allowance.
- Find out more: cash Isa rules and allowances