Income Tax

Marginal Tax

Income tax is a tax that you have to pay on your income. For most people, a portion of your income is not taxed. This is called your Personal Allowance.

The UK operates a marginal tax system, which means for every £1 you earn over a set threshold, you only pay that tax rate on that part of your income, not on your total income.

A common misunderstanding is that once you reach the 40% tax bracket, you then pay 40% on all your income and are therefore worse off. However, you only pay 40% on any of your income which falls within the 40% tax bracket.

For example, if someone earns £60,000 gross income, which falls into the higher 40% tax bracket which begins at £50,271:

• £12,570 is their personal allowance, which is tax free (0%)
• £12,570 - £50,271 tax band is taxed at 20%
• The remaining income from £50,271 - £60,000 is taxed at 40%

In total they are only taxed on the £47,430 which is above their personal allowance, and they end up with a total income tax of £7,540 from the 20% bracket and £3,888.40 from the 40% bracket.

What is taxed?

You pay income tax on other things in addition to money earned from employment:

• profits you make if you’re self employed
• some state benefits
• pensions, including state, company and personal
• rental income
• benefits from your job
• income from a trust
• interest on savings (over savings allowance)

However, you do not need to pay tax on:

• the first £1,000 of self-employment income - “trading allowance”
• the first £1,000 of income from property you rental
• income from tax-exempt accounts, such as ISAs
• dividends from company shares under your dividens allowance
• some state benefits
• premium bond or national lottery wins
• rent from a lodger (if below Rent a Room scheme limit)

Personal Allowance

Your personal allowance is the amount you can earn without paying tax. This is determined by HMRC and can be affected by income or your tax code.

The tax code is automatically given to your employer so that they can deduct the correct amount of tax each month automatically from your pay (this assumes PAYE, most employees are).

The default and most common tax code is 1257L, which gives you a personal allowance of £12,570 before you start paying any income tax.

Your personal allowance resets at the start of every tax year which runs from the 6th April to the 5th April of the following year.

The current tax year is 6th April 2025 to 5th April 2026.

Personal Allowance Decreases

However, for individuals with an adjusted net income above £100,000, their Personal Allowance is gradually withdrawn.

For every £2 of income earned above £100,000, £1 of Personal Allowance is removed.

This continues until the Personal Allowance is fully eliminated at £125,140.

For example, if someone earns £110,000:

• Income above £100,000 = £10,000
• Personal Allowance reduction = £10,000 ÷ 2 = £5,000
• Remaining Personal Allowance = £12,570 - £5,000 = £7,570

Therefore, by £125,140, the full £12,570 personal allowance has been removed

Why this matters

Because the withdrawn allowance was previously tax-free, losing £1 of allowance means that £1 of income becomes taxable at 40%.

This creates an effective marginal tax rate of 60% between £100,000 and £125,140:

• 40% higher rate income tax
• Plus 20% tax on the withdrawn allowance

This is sometimes referred to as the “60% tax trap”.

However, you can contribute some of your gross salary to your tax-free pension and bring down your taxable income to £100,000 to avoid this trap entirely.

Income Tax Rates

Below is a table which shows the tax rates you pay in each band if you have a standard personal allowance of £12,570.

How Income Tax is Paid

Most people in the UK pay income tax through PAYE. This is a system your employer or pension provider uses to take Income Tax, and National Insurance contributions before they pay you your wages or pension.

This is done automatically and is your employer and the government’s responsibility.