Understanding Income Tax in the UK
Demystifying how income tax rates and bands really work
A recent poll suggests that many adults in the UK do not fully understand how income tax works.
This lack of understanding can lead to missed opportunities or poor financial decisions. In this guide, we aim to clarify how income tax is calculated, explain common misconceptions, and provide examples and visuals to help you feel more confident about your income tax.
What’s Inside This Guide
- Misunderstanding income tax rates and bands
- How tax rates and bands work
- Income tax bands explained using a pie analogy
- Examples of how income tax is calculated
- What is a marginal tax rate?
- Why understanding tax bands matters
- Example: Working extra hours or accepting a promotion
Common Misunderstanding: Income Tax Bands
Many believe that once their income enters a higher tax band, all of their income is taxed at that higher rate – but this is incorrect!
👉 You can see the results of the related poll on the Tax Policy Associates website.
This guide explains how tax bands apply only to the portion of income that falls within each band—not to your entire income.
Note: This article applies to taxpayers in England, Northern Ireland, and Wales. If you live in Scotland, see our separate article for Scottish taxpayers.
How Income Tax Bands Work
The UK uses a progressive tax system, which means:
- Higher incomes are taxed at higher rates.
- You only pay more tax on the portion of income that falls into each tax band.
This article focuses on income tax only, excluding National Insurance Contributions (NICs).
Think of Income Tax as a Pie
Imagine your annual income as a pie. The government (HMRC) takes slices of this pie based on your income level.
Here’s how the slices work:
- Personal Allowance:
- First £12,570 of income
- Tax-free
- Basic Rate Band:
- From £12,571 to £50,270
- Taxed at 20%
- Higher Rate Band:
- From £50,271 to £125,140
- Taxed at 40%
You only pay the higher rate on the portion of income above £50,270 – not your entire income.
Check out the current rates on our Tax and NIC rates and bands webpage.
Example: Tax Breakdown for Bilkis
Scenario:
- Bilkis lives in England
- Earns £55,000 in 2024/25
- No other income
Tax calculation:
- £12,570 is tax-free (Personal Allowance)
- £37,700 taxed at 20% → £7,540
- £4,730 taxed at 40% → £1,892
Total income tax = £7,540 + £1,892 = £9,432
🔍 Effective tax rate = 17%, not 40%!
If Bilkis paid 40% on all her income:
£55,000 × 40% = £22,000 ❌
That’s clearly not the case.
Understanding Marginal Tax Rate
Marginal tax rate is the rate you pay on your next £1 of income.
Example: Larisa in Northern Ireland
- Earns £51,000
- Taxable income exceeds the higher rate threshold
- Her marginal tax rate is 40%
👉 If her salary increases by £1, she pays 40p more in tax, keeping 60p.
Why This Matters
Misunderstanding tax bands may cause people to turn down beneficial opportunities, such as:
- Promotions
- Overtime hours
- Second jobs
- Extra contracts (for self-employed individuals)
Example: Extra Hours at Work
Sean, a Welsh taxpayer, earns £48,000 in 2024/25. He’s offered a promotion increasing his salary to £52,000.
- The Welsh higher rate starts at £50,270
- He wrongly assumes all his income will be taxed at 40%
After speaking to a Chartered Tax Adviser, Sean learns:
- Only £1,730 will be taxed at 40%
- The rest remains in the 20% band
- Tax increase:
- 20% of £2,270 = £454
- 40% of £1,730 = £692
- Total tax increase = £1,146
- Net gain = £2,854
Sean now decides based on the role, not tax fear.
Key Takeaways
- You don’t pay higher rates on all your income—just the portion in that band.
- Your marginal rate tells you how much tax you'll pay on extra earnings.
- Understanding tax bands can help you make better financial decisions.
Contact
SBX if you would like advice about your tax situation.
