Your payslip can be difficult to get your head around, especially when it comes to understanding your tax code
For those who get a regular payslip, many of the numbers on it can be a bit of a mystery. We generally just trust that the right amount of income tax, National Insurance and other deductions are being taken off. But what do the different numbers mean, and how can you check if they're right? Here, we'll focus on income tax, but you can find out about the other things that affect your payslip by reading our articles on National Insurance and pension deductions.
Probably the most mysterious part of your payslip is your 'tax code' – the very fact that it is called a code suggests that perhaps you're not meant to understand it! Royal London's Good with your money guide: Decoding your tax code is designed to help you make sense of your tax code, understand what the letters and numbers mean and how you can check if they're correct.
How does your tax code work?
In simple terms, your tax code tells your employer or pension provider how much of your income they should ignore before they start to apply income tax. In most cases, a higher tax code is a good thing.
Most people have relatively simple tax affairs, with one source of taxable income, such as one job or one pension. In the 2020/21 tax year, people can earn £12,500 before they have to pay tax – this is your annual tax-free allowance. HM Revenue and Customs (HMRC) takes this figure, takes off the final digit (to give 1250 in 2020/21, for example) and sends this as a tax code to your employer. It also adds a final letter to give further instructions to your employer. The most common final letter is 'L', which simply tells your employer to apply the standard rate of income tax (currently 20%) to the first £37,500 above the tax-free amount, and then higher and additional rates beyond that. Many people will, therefore, have a tax code of 1250L in 2020/21.
Rates and bands may be different in Scotland, so Scottish taxpayers have an 'S' at the start of their tax code to alert their employer to deduct tax at a different rate.
The Decoding your tax code guide also explains the many other different code letters that can appear at the start or end of your tax code. These can arise if, for example, you have claimed the Marriage Allowance, or if no tax at all is payable on a particular source of income.
Things start to get a bit more complex for people who have multiple sources of taxable income, such as two jobs or two pensions. The annual tax-free allowance applies to your total income for the year, not to each individual job or pension. This means that HMRC has to allocate that total allowance across your different sources of income. As a result, you're likely to have a different tax code for each source of taxable income.
One potential error can arise when you first start receiving a payment, and HMRC doesn't have enough information to work out the right tax code for you. Often, you can be on a temporary or 'emergency' tax code until there is enough information, and this means you can sometimes be under or over-charged for a considerable period of time.
If you think your tax code is wrong, it's worth contacting your tax office so that the right amount of tax can be deducted as soon as possible.
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