Taxes aren’t the most exciting part of managing your money — but they might be the most important. Pay too little, and HMRC will come knocking. Pay too much, and you’re giving away money you could have kept.
The good news? Once you understand how the system works, taxes stop being a mystery. They become just another part of your financial toolkit — something you can plan for, reduce where possible, and manage with confidence.
This guide takes you through everything you need to know about UK taxes, step by step. By the end, you’ll know not just how the system works, but also the practical moves you can make to keep more of your hard-earned money.
The UK Tax System Explained
Think of the UK tax system as a series of buckets. Every time you earn money, spend money, or invest money, there’s a chance HMRC will want a share. But each bucket works differently.
Income Tax is charged on your salary, wages, or pension.
National Insurance funds state benefits and the NHS, and is also based on your earnings.
Capital Gains Tax (CGT) applies when you sell assets (like shares, a rental property, or even crypto) for a profit.
Dividend Tax is paid if you own shares in companies and receive dividend payouts.
Corporation Tax is for limited companies on their profits.
VAT is included in most things you buy, though you don’t always notice it.
Council Tax is set locally and pays for rubbish collection, libraries, and local services.
Each tax has its own rules, allowances, and thresholds. And here’s the key: understanding those rules is the first step to not overpaying.
Key UK Tax Rates & Allowances (2025/26)
| Tax / Allowance | Amount / Rate | Notes |
|---|---|---|
| Personal Allowance | £12,570 | Tax-free income. Reduced £1 for every £2 earned above £100,000. |
| Basic Rate (Income Tax) | 20% (up to £50,270) | After the Personal Allowance. |
| Higher Rate (Income Tax) | 40% (£50,271 – £125,140) | Effective rate increases once allowance is reduced. |
| Additional Rate (Income Tax) | 45% (above £125,140) | No Personal Allowance at this level. |
| National Insurance (Employees) | 8% on £12,570 – £50,270; 2% above £50,270 | Class 1 contributions. |
| National Insurance (Self-Employed) | 6% on £12,570 – £50,270; 2% above £50,270 | Class 4. Class 2 abolished from April 2024. |
| Dividend Allowance | £500 | Tax-free dividend income. |
| Dividend Tax Rates | 8.75% (basic), 33.75% (higher), 39.35% (additional) | Applied after the allowance. |
| Capital Gains Tax (CGT) Allowance | £3,000 | Tax-free gains each year. |
| CGT Rates (most assets) | 10% (basic), 20% (higher/additional) | Excluding property. |
| CGT Rates (property, not main home) | 18% (basic), 24% (higher/additional) | Lowered in 2024. |
| ISA Allowance | £20,000 | Cash, stocks & shares, Lifetime ISA, or a mix. |
| Pension Annual Allowance | Up to £60,000 (tapered for high earners) | Tax relief at marginal rate. |
| Marriage Allowance Transfer | £1,260 | Can reduce tax by up to £252 a year. |
| Inheritance Tax (IHT) Threshold | £325,000 (plus £175,000 residence nil-rate band) | Above this, taxed at 40%. |
| VAT Standard Rate | 20% | Reduced rates: 5% (e.g. energy), 0% (e.g. food, children’s clothing). |
Last updated: September, 2025
How Income Tax Really Works
If you’re employed, your tax is usually handled through PAYE — money is taken from your salary before you even see it. Simple, right?
Not always.
You get a Personal Allowance (currently £12,570) before paying any tax.
After that, income is split into bands:
20% basic rate (up to £50,270)
40% higher rate (up to £125,140)
45% additional rate (above £125,140)
Here’s an example:
If you earn £60,000 a year, you don’t pay 40% tax on the whole amount.
You pay:
Nothing on the first £12,570
20% on £37,700 (£7,540)
40% on the remaining £9,730 (£3,892)
Your average tax rate is closer to 19%, not 40%. This is where people often get confused.
Why this matters:
Knowing your band helps you plan salary sacrifices into pensions, or split income with a spouse.
Misunderstanding it often leads to people thinking they’re worse off after a pay rise (they’re not).
National Insurance: The “Other” Income Tax
Most people think about Income Tax but forget about National Insurance (NI). If you’re employed, you’ll pay Class 1 NI contributions; if self-employed, you’ll deal with Class 2 and Class 4.
NI rates are lower than Income Tax, but the effect is similar — they reduce your take-home pay. Crucially, NI also counts towards your State Pension record, so missing contributions could reduce your retirement income.
PAYE vs Self-Assessment
If you’re an employee, PAYE (filed by your employer) does most of the heavy lifting. But if you have side income — freelancing, rental property, selling online, or investing — you may need to file a Self-Assessment tax return.
Self-Assessment can feel intimidating, but it boils down to:
Register with HMRC.
Keep records of your income and expenses.
Submit your return (usually by 31 January).
Pay what you owe (and possibly payments on account for the next year).
The biggest mistake we see? People waiting until January to start. By then it’s stressful. The earlier you prepare, the more time you have to find mistakes, claim reliefs, and plan your payment.
Property and Investment Taxes
Rental Property
If you rent out a property, you’ll pay tax on your profits. Profits are simply rental income minus allowable expenses — things like letting agent fees, repairs, insurance, and maintenance.
What you can’t do anymore is deduct your full mortgage interest. Instead, you get a basic rate tax credit (known as Section 24). This means higher-rate taxpayers may face bigger bills than expected.
See our in-depth article on investment properties.
Capital Gains Tax (CGT)
Sell a second property or shares at a profit, and CGT comes into play. Everyone gets an annual exemption (currently £3,000), but above that you’ll pay 10%–28% depending on the asset and your tax band.
Planning tip: If you’re married, you can transfer assets to your spouse before selling to use two exemptions instead of one.
When selling your personal property, CGT has special consequences. We do a deep dive in our primary residence article.
Dividends
Owning shares in a company can be rewarding, but dividends are taxable. You do get a small tax-free allowance (£500 for 2024/25), but anything above that is taxed at 8.75%, 33.75%, or 39.35% depending on your income level.
Reliefs and Allowances You Shouldn’t Miss
This is where tax starts working in your favour.
ISA allowance – up to £20,000 a year of tax-free savings and investments. Read more about ISA's & LISA's.
Pension contributions – get tax relief at your highest rate (a £100 contribution only costs £60 if you’re a higher-rate taxpayer). We have two full guides on personal and employer-pensions.
Marriage Allowance – worth up to £252 a year if one spouse earns below the allowance. See this article where we discuss money and relationships.
Gift Aid – boosts donations and can give higher-rate taxpayers extra relief.
Trading and property allowances – if you earn small amounts from a side hustle or renting out a room, these may save you paperwork and tax.
Used correctly, these allowances are the difference between paying “the standard” and paying “the smart amount.”
Tax Planning and Optimisation
Once the basics are covered, you can move into optimisation. This isn’t about “dodging” tax — it’s about arranging your affairs sensibly.
Salary vs dividends if you run your own company.
Pension contributions to reduce higher-rate tax.
Splitting assets with a spouse for better use of allowances.
Timing disposals (selling investments across two tax years to double exemptions).
Done right, these strategies mean you’re not just paying tax, you’re managing it.
Final Thoughts
Taxes can feel heavy, but they don’t have to be. Once you understand the rules, the power shifts back to you. You’re no longer just “hoping HMRC got it right” — you’re actively managing what you owe and protecting your income.
Remember: pay the right amount, not a penny more.
