In focus: Taxes
When you’re new to adult life, tackling taxes can feel like trying to learn a whole new language. But what if we told you they’re not as complicated as they might seem?
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If the world of taxes feels a little alien to you, you’re not alone. Research has found that 78% of people say they don’t know enough about tax, while 76% believe that there should be more tax education in schools*.
Maybe you’re keen to boost your understanding of why we pay taxes, the different types of tax, when it’s paid or how the different tax bands work? Lewis McCree and Olivia Sizeland from The Money Charity have a combined 12 years' experience working in the world of money, so we asked them to spill the tea on taxes.
What is tax, and why do we pay it?
Tax is probably one of those things that's been on your radar for a while, but perhaps hasn’t had your full attention. But once you take flight into adult life, it’s kind of unavoidable. Put simply: tax is something almost all of us must pay. It can be added onto a product or service (known as VAT – Value Added Tax), or be taken from your wages or business profits, and goes directly to the government.
“One of the main reasons we pay tax is to help fund essential services like the NHS, the police, social benefits, roads and education, and different kinds of taxes are divided up to pay for different things,” Olivia explains.
Both individuals and businesses must pay tax, and how much we pay (the tax rate) is decided by the government. Tax rates, as a percentage, are usually reviewed every year.
What different types of tax are there?
“The short answer is...there are tons of different types of tax!” says Lewis. “But the ones the general population will encounter are National Insurance, Income Tax and Council Tax.”
Income Tax and National Insurance are usually taken directly from your wages if you are a PAYE (Pay As You Earn) employee, while Council Tax will generally be paid via a standing order or direct debit that you will need to set up yourself.
“You might hear people talking about other taxes such as Capital Gains Tax, Inheritance Tax, Stamp Duty... the list is pretty endless. But the main ones young adults need to have on their radar are National Insurance, Income Tax and Council Tax,” Lewis adds.
When do I need to pay taxes?
“If you’re aged 16 or over and have a paying job earning more than £12,570 a year, you’ll need to pay National Insurance and Income Tax,” explains Olivia. “And by year, that means the tax year, which usually runs from 6 April of the current year to 5 April of the next.”
The amount you pay in National Insurance depends on which of the four main classes of National Insurance you fall into:
- Class 1: for employees and employers
- Class 2: for those who are self-employed
- Class 3: voluntary contributions (e.g., to help make sure you have enough qualifying years to get the full State Pension if you have gaps in your record)
- Class 4: for those who are self-employed and earn over a certain amount
You can find out more about which National Insurance class you are in here.
“When it comes to Income Tax, you won’t pay anything on the first £12,570 you earn. This is called your Personal Allowance. Once you start earning more than £12,570 though, you’ll fall into one of several tax bands, which increase incrementally as you begin to earn more money,” says Lewis.
Council Tax is an annual fee your household must pay to your local council. The cost is decided by them, and most people will pay it in ten monthly instalments, followed by two months (February and March) of no payments. How much Council Tax you pay depends on your personal circumstances, the valuation band your property is in (a different story, for another time!) and how much your council needs for its services.
You can look up more details about your Council Tax depending on whether you live in England, Scotland or Wales. If you live in Northen Ireland things work slightly differently, and instead of Council Tax, payments are called Rates.
How do tax bands work?
“Currently, any money you earn between £12,571 and £50,270 will have 20% income tax applied,” says Lewis. “But that doesn’t mean if you’re earning £20,000 you’ll pay £4,000 of that per year in Income Tax. You only pay 20% tax on the excess over your £12,570 personal allowance,” explains Lewis.
Which tax goes where?
National Insurance: Goes towards things like State Pensions, Jobseeker’s Allowances and Maternity Allowances.
Income Tax: Funds public services like healthcare, education and the welfare system.
Council Tax: Helps to pay for things like police and fire services, parks, libraries, and rubbish collection.
Numbers check!
Wage: £20,000 per year
Personal Allowance: £12,570
Taxable income: £20,000 - £12,570 = £7,430
20% of this: £7,430 ÷ 100 x 20 = £1,486
Monthly income tax payment: £1,486 ÷ 12 months = £123.83
This system continues and grows as you move through the tax bands. For example, if you earn between £50,271 and £150,000, you will pay 40% tax on the excess over the previous band’s upper range (£50,270). For anything over £150,000 you’ll pay 45% tax.
“It’s a very common misunderstanding that once you start earning a higher amount, you’ll be required to pay 45% tax on your full wage. What you actually pay is relative to the tax band you are in,” says Olivia.
So, if you reach the point where you are earning £60,000 a year, you don't have to pay 40% tax on your entire wage. Instead, you would pay:
0% tax on the first £12,570
20% tax on the next £37,700
40% tax on the final £9,730
Remember too that the figures given here may change from year to year, however the formula used will likely stay the same.
How do taxes work if I’m self-employed or have a side hustle?
Once you become self-employed, or start a side hustle alongside your regular job, you should let HMRC (His Majesty’s Revenues & Customs, the UK’s tax authority) know. The latest you can register this is by 5 October after the end of the tax year during which you become self-employed. So, if you started your business in July 2023, you’d need to register with HMRC by 5 October 2024.
“If you have a side hustle or are self-employed, you are responsible for calculating your taxes yourself. But don’t worry, this isn’t as complicated as it seems once you know where to begin!” says Oliva. “First things first: check your employment status using this HMRC tool. If this determines you as self-employed, you can register on the Gov.uk website and then fill in the self-assessment form to calculate how much income tax you owe. It will walk you through the rest,” she adds.
“Another good-to-know piece of info is that if you are self-employed, there’s something called a Trading Allowance that you may be eligible for,” says Lewis. “This is where you can earn up to £1,000 per tax year and not pay any tax on that. It helps a little when you’re just starting something up and you’re not yet profiting massively from it,” he adds.
Where can I go for help if I have more questions about taxes?
“MoneyHelper.org is brilliant and Gov.uk has loads of helpful info that is generally easy and straightforward to use. We’ve got lots of resources at The Money Charity for young people too, like the Student Money Manual and our workshops and webinars for groups,” says Olivia.
“We also have a handy signposting page that can point you in the direction of other organisations out there offering financial support and more specific advice, like Turn2us.org and Entitledto.co.uk,” says Lewis.
Plus, don’t forget MoneySense has a whole hub dedicated to helping you find greater financial confidence and support when it comes to a range of tricky topics like cryptocurrency, payday and credit scores – don't miss it.
MYTH VS REALITY
Myth: There’s no point earning more, because I’ll just end up paying loads more tax.
Reality: “When I was younger, I thought ‘what’s the point in trying to earn more because I’ll just be taxed so much more,’” says Olivia. “But it’s important to remember that it’s only the extra amount that you’re earning over the previous band that’s taxed at that higher rate.”
Myth: I don’t have to pay any council tax if I’m a student.
Reality: Not necessarily. If everyone in your house is a full-time student, you won’t need to pay any council tax. This means you’re all enrolled on a course that lasts at least a year and requires at least 21 hours of study each week. If you or any of your housemates are part-time students, you will generally need to pay. You may be able to get a reduction based on other factors though, for example if you are the only non-full-time student in the house. If you live in a house-share with both full-time students and non-students, you'll receive a council tax bill each month. However, only the non-student tenants will need to pay – it’s always worth checking with your council for the specifics, though.
Myth: HMRC will let me off me if I don’t fully understand tax.
Reality: Unfortunately, this is not the case. Claiming ignorance as an excuse for an error or missing tax deadlines won’t mean HMRC will let you off the hook. They expect everyone to keep track of the necessary records for an accurate and on-time tax return. So, now’s the perfect time to brush up on your knowledge!
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