The Basics of Income Tax

Simply put, income tax is the money the government takes from your income to fund itself. It is typically taken from salaries paid by employers, employee benefits, state benefits, savings and pensions.

Historically, income tax was bitterly opposed at its inception in the United Kingdom and was only passed through parliament in order to pay for the material necessary to fight the Napoleonic wars. Sadly it proved to be such a great boost to the state’s finances that it remains in place to this day and is an accepted and integral part of the British economy, helping to fund everything from pensions and welfare to the NHS.

That’s very interesting, but does it affect me?

The vast majority of working people whether full or part-time, self-employed or temporary are required by law to pay income tax. Most full or part-time workers employed by a company will have this money deducted by their employers and sent directly to HMRC (Her Majesty’s Revenue and Customs). The odds range from high to certain that if you are receiving wages for work of any kind, you will owe income tax to the government are legally required to pay it. Virtually nobody gets away with it. After all, wasn’t it Benjamin Franklin who said, “The only things certain in life are death and taxes”?

Great, so how much do I owe?

Provided that you earn less than £100,000 and are younger than 65, you have a ‘personal allowance’ of £9,440 (tax year 2013-14) which is the amount of your income that cannot be taxed. If you are earning less than this you do not have to pay any income tax whatsoever and should contact your Tax Office as you may be entitled to a refund. After this amount there are three tax bands, the basic rate, the higher rate and the additional rate.The basic rate is 20% and applies for all incomes up to £32,010, the higher rate is 40% and applies for incomes ranging between £35,001 and £150,000 and the additional rate is 50% and applies for all incomes above and including this amount.

How do I pay?

Depending on your type of income and whether or not you are self-employed, you pay your income tax in different ways. For most of us, as employees our income tax is deducted through PAYE (Pay as you earn) using the tax code HMRC provides to the employer and these deductions are sent directly to HMRC, meaning you don’t have to worry about doing anything as it’s all worked out for you.

Income tax on savings is generally deducted at source before you receive it. If you are self-employed you will need to register for self-assessment and complete a self-assessment tax return, which can be done online. Payment can then be dealt with through multiple instalments if necessary. Those of us who earn money through many different avenues such as rent or investments could be considered to have complex tax affairs and may also be required to complete the self-assessment process.

I took out a student loan at University, how is this going to affect my income and when will I have to start repaying it?

Student loan repayments happen automatically when your income rises over a certain threshold, which is specified by your student loan plan. The Student Loans Company passes on the details of those people who are due to repay their loans to HMRC, who in turn send a ‘Start repayment’ notice to anyone who employs this individual and provided their income is above the threshold specified by their student loan plan, the deductions are calculated and taken automatically. The exception to this is if you are self-employed, in which case you are responsible for calculating and repaying this amount yourself.

What’s all this about a plan? How do I know which plan I’m signed up to?

If you took out a loan before Semptember 1998 you are on a Mortgage Style or Fixed Term Loan and should skip down a few sections to see the information relevant to you. If you took out a student loan during or after September 1998, which is likely to be the case for the majority of people visiting this website, you are on an Income Contingent Loan.

There are two types of Income Contingent Loans, with the kind of imaginative names that only career financiers can come up with, Plan 1 and Plan 2. Luckily, it isn’t difficult to figure out which one you are on. If your home address was in Scotland or Northern Ireland at the time of applying for your loan, you are on Plan 1. However, if your home address was in England or Wales at the time of your application and you made your application after 1st September 2012, you are on Plan 2. If your home address was in England or Wales and you made your application before 1st September 2012, you are on Plan 1.

So now I know which plan I’m on, how much will I be paying?

If you are on Plan 1, the threshold to start repayments is a £15,795 annual wage (changing to £16,365 in April 2013), which equates to a £1,315 monthly wage and a £303 weekly wage. If you are earning more than this amount, simply subtract this threshold from what you are earning and take 9% of this new figure to work out what your repayments will be.

So for example if I earn £1,750 a month I will subtract the monthly threshold of £1,316 and be left with £434, of which 9% (£39) will be the amount I pay monthly.Plan 2 has an annual threshold of £21,000, a monthly threshold of £1,750 and a weekly threshold of £483 but other than that the repayments are calculated in exactly the same way. From 1 September 2012, until further notice, the interest rate for the existing Income Contingent Loans was set at 1.5%.

Mortgage Style or Fixed Term Loans

These types of loans are typically repaid in monthly instalments by Direct Debit.If you have four or fewer loans for courses beginning before 1998, you will repay them over 60 monthly instalments. If you have five or more loans you will repay them over 84 monthly instalments. The monthly repayment amount is calculated on the basis of the total amount borrowed, plus interest (based on the rate of inflation), divided by the total number of months over which you repay.

If you have a gross monthly income of £2,318 or less(equivalent to £27,813 per year) you may be eligible to apply for deferment.

To apply for deferment you must supply evidence of income via an application form that can be requested by calling 0845 073 8890. If your application for deferment is successful your repayments will be postponed for twelve months. If you are in receipt of a state pension the standard rules with respect to income tax still apply. This means that if your income exceeds the personal allowance for that tax year you are still required to pay income tax.

The good news is your personal allowance is slightly larger, being £10,500 for 65-74 year olds and £10,660 for anyone older than this. The bad news is that the threshold at which your personal allowance starts to decrease is lower than that of younger tax payers, being £24,400 for both age groups. After this amount your personal allowance decreases by half of the total amount you have over that limit, so for example if you're 66 and have income of £25,900 - £500 over the limit - your age-related Personal Allowance is reduced by £250 to £10,250.

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