How Does A Change In Earnings Affect My Tax?

For employees whose income patterns are predictable tax can be collected solely through PAYE and the tax code supplied by HMRC to the employer means tax is deducted at source. The 2020/ 21 tax year is far from normal with millions of workers facing disruption to their earnings and uncertainty about their future. This could mean a reduction or increase in the tax due over the whole year. When circumstances change the prevailing tax code issued is less likely to reflect the true position and so taxpayers may need to take action to claim refunds due to them or set aside some savings for extra tax due.

Changed circumstances may also mean that a taxpayer becomes eligible for tax allowances which they were previously ineligible to claim. The main allowances affected are available to married couples and civil partners, those with children, interest on savings accounts and pension savings tax relief. We will highlight some of these but as tax liability depends on personal circumstances, which cannot be fully explored here, advice may be needed to fully understand your personal position.

The first step is to be aware of the income tax bands which apply to each layer of income.     

Tax Rates

Income tax is charged in bands of income and for most UK taxpayers these apply the following levels of income.

Annual taxable income  (6/4/20 – 5/4/21)

Rate charged on each band of income

£12,500

Nil

£12,501 - £50,000

20%

£50,001 - £150,000

40%

£150,001 plus

45%

Taxpayers resident in Scotland have the same £12,500 tax free allowance but different bands and rates apply. 41% tax is payable in Scotland on incomes over £43,430 and 46% over £150,00 with 3 lower bands at 19%, 20% and 21%.

Most taxpayers whose total taxable income is below £50,000 will have a tax code of 1250L. This means that the first £1,041.66 of monthly pay will be tax free with 20% deducted on earnings up to £50,000.  If tax deducted on your payslip is different you may be under or overpaying tax, unless you either owe tax from a previous year or have additional allowances available which reduce your tax liability.

Those with income in excess of £100,000 lose £1 of the tax -free allowance for every £2 they exceed this, so that those with income over £125,000 get no personal allowance. 

When changing income patterns result in falling into a lower tax bracket, other allowances may become available.

Married Couples and Civil Partners

Where one is a nil rate taxpayer and the other a basic 20% rate taxpayer, the lower earner may elect to transfer 10% of their tax- free income allowance to the other. This saves the taxpayer up to £250 per year by increasing their personal allowance by £1,250. If eligible in previous years for this allowance, up to 4 years arrears may be claimed resulting in a tax refund of up to £1,188. Cohabiting couples are ineligible for this allowance.

Parents with dependent children

Child benefit is available to all parents of under 16s or those under 20 if in full time education. It is paid at £21.05 pw. for the first child and £13.95 pw. for each subsequent child. It is not means tested and is tax free unless one parent or their partner has income above £50,000. For each £100 of taxable income above this it is taxed at 1% so that those with income over £60,000 will pay 100% tax on the Child Benefit.

 If income drops below this threshold a claim may be made using form CH2 on the Government website. It can only be backdated for 3 months, so if in doubt about future earnings, claiming early is advisable as the tax bill will never be more than 100% of the benefit received. Not claiming is giving up money which cannot be claimed later.

Tax Free Childcare

Parents of 3 and 4 year olds, where both are working and usually earning at least £139.52 per week (£131.20 if under age 25), are entitled to 30 hours of free childcare per week.  They can also open a Tax- Free Childcare Account on the Government website to pay for childcare for under 12s. Every £8 saved is topped up to £10 by HMRC. Parents may save up to £8,000 per year and get up to £2,000 per child. This account can then fund the cost of childcare with providers registered with the Government scheme including nurseries, after school care, childminders, nannies and some sports clubs.

Parents where one is earning more than £100,000 are ineligible for these allowances but could claim them if their income falls below this.  Critical workers, whose earnings temporarily exceed £100,000, will remain eligible and the minimum income requirement has been waived until 31 August.

Savers in receipt of savings income

Tax free allowances are available in addition to any Individual Savings Accounts which can pay interest tax free.

Taxable Income Per Year Tax Free Savings Allowance
Under £12,500                                 Up to £13,500
£12,500 - £18,500 Up to £ 18,500
£18,500 - £50,000 Up to £1,000
£50,001 - £150,000 Up to £500
£150,001 and above Nil

Married couples and civil partners may save tax by transferring ownership of assets to a lower taxpaying spouse or civil partner.

Pension Savings

Savings made into pension schemes, within the available annual allowance, attract tax relief at the taxpayer’s marginal income tax rate. Pension savings can be used to reduce other taxable income which may mean that eligibility for other allowances is restored.  For example, reducing a parent’s taxable income below £50,000 at which child benefit becomes tax free, or restoring the nil rate of tax on the first £12,500 of income for those who earn over £100,000. 

Please remember, no news or research item is a recommendation or advice to buy. Aspira Corporate Solutions Ltd is not responsible for accuracy and may not share the author’s views. The contents of this blog are for information purposes only and do not constitute individual advice. All information is based on our current understanding of taxation legislation and regulations. The Financial Conduct Authority does not regulate estate planning, tax advice, wills or trusts.

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