Order of Taxation
Learn how different types of income are taxed and how they fit into a client’s income tax calculation.
Summary
In terms of income the main categories are non-savings non-dividend income, savings income (including offshore bond gains), dividend income and onshore bond gains.
Allowances and tax bands
Tax Bands (E&W) 2024-25
|
Personal Allowance £12,570* |
taxed at 0% |
|
Up to £37,700 |
taxed at 20% |
|
£37,700 to £125,140 |
taxed at 40% |
|
Income over £125,140 |
taxed at 45% |
Personal Allowance (PA)
* Each tax year, almost every individual is entitled to a personal allowance. For the tax year 2024-25 it is £12,570 and it is reduced by £1 for every £2 of net adjusted income in excess of £100,000. It will therefore be zero when income exceeds £125,140.
**An individual’s personal allowance is usually set against non-savings non-dividend income first, followed by savings and dividend income, but it can be applied in the most beneficial way for the taxpayer. This is known as beneficial ordering.
Starting rate for savings band (SRSB) up to £5,000
The first £5,000 of savings income is taxed at 0%. The SRSB of £5,000 is reduced by £1 for every £1 of non-savings income above the personal allowance.
This is therefore unavailable where an individual's non-savings income exceeds the combined total of their personal allowance plus £5,000.
Personal Savings Allowance (PSA)
|
£1,000 (basic rate taxpayer) |
|
£500 (higher rate taxpayer) |
|
£0 (additional taxpayer) |
Dividend Rates
|
First £500 |
taxed at 0%** |
|
Up to £37,700 |
taxed at 8.75% |
|
£37,700 to £125,140 |
taxed at 33.75% |
|
Income over £125,140 |
taxed at 39.35% |
**If the individual’s PA is being set against dividend income in line with beneficial ordering, the PA applies first then the £500 at 0%.
Notes:
When calculating entitlement to personal allowance, starting rate for savings band and personal savings allowance, in the main income tax calculation, it is the whole chargeable gain and not the top sliced gain that is used.
In the top slicing calculation, the personal allowance, starting rate for savings band and personal savings allowance entitlement can be recalculated based on the top sliced gain.
Sources of income
When dealing with clients with more than one source of income, it is important to understand the order in which each source is taxed.
Non-savings, non-dividend income
Firstly, you need to consider non-savings non-dividend income. This includes employment income, self-employment income, pension income, rental income and some taxable state benefits for example state pension, jobseeker’s allowance, bereavement allowance.
Next you need to consider savings income and dividend income. This also has an order in which it is assessed.
Savings income (including offshore bond gains)
Savings income can consist of interest payments from banks and building societies, corporate bonds, interest from a fixed interest fund (OEICs/GIAs) and offshore bond gains (savings income without a tax credit).
Where an individual has both savings and dividend income, the amounts taken together are treated as the next part of their income, and the dividend income is taken as the highest part of the combined amount.
The first £5,000 of savings income can be set against the starting rate for savings band (SRSB).
An individual also has a personal savings allowance (PSA) which is currently £1,000 for a basic rate taxpayer, £500 for a higher rate taxpayer and £0 for an additional rate taxpayer.
Any savings income in excess of the allowances and starting rate savings band, if applicable, is taxed at 20%, 40% or 45%.
Dividend income
These are payments such as dividend payments from shareholdings or dividend distributions from OEICs and unit trusts.
The first £500 of dividend income is taxed at 0%. Any dividend income exceeding the £500 allowance up to the higher rate band is taxed at 8.75%. Any dividend income over the basic rate band is taxable at 33.75% or 39.35%.
If there is any unused personal allowance, it is set against the savings and dividend income in the manner most beneficial to the individual. (section 27 Income Tax Act 2007).
Savings income with a tax credit
Onshore bond gains are classed as savings income but, due to the tax credit
attached to them, they are taxed in a different position to offshore bond gains.
The highest part of an individual’s income is onshore bond gains (savings income without a tax credit).
Examples |
Individual with the following income: |
||
| • Pension income | £11,000 | |
| • Savings income | £ 6,000 | |
| – Interest | £4,000 | |
| – Offshore bond gain | £2,000 | |
| • Dividend income | £10,000 | |
| Non-savings income | Savings income | Dividend income | |
| Pension income | £11,000 | ||
| Interest | £4,000 | ||
| Offshore bond gain | £2,000 | ||
| Dividend income | £10,000 | ||
| Personal allowance | £11,000* | £1,570** | |
| Dividend allowance | £500 | ||
| Starting rate savings band | £5,000 | ||
| Personal savings allowance | £1,000 | ||
| Taxable income | £0 | £0 | £7930 @8.75% |
| Tax payable | £0 | £0 | £694 |
* Personal allowance is £12,570, so unused personal allowance is £1,570.
Next, we need to consider the savings and dividend income. The SRSB and PSA can be used. Therefore £5,000 and £1,000 (basic rate taxpayer) can be set against the savings income which includes the offshore bond gain.
** As the taxable savings income is zero, it is most beneficial to the individual to use the unused personal allowance against the dividend income.
Individual with the following income: |
||
| • Pension income | £11,000 | |
| • Savings income | £ 9,000 | |
| – Interest | £7,000 | |
| – Offshore bond gain | £2,000 | |
| • Dividend income | £10,000 |
| Non-savings income | Savings income | Dividend income | |
| Pension income | £11,000 | ||
| Interest | £7,000 | ||
| International bond gain | £2,000 | ||
| Dividend income | £10,000 | ||
| Personal allowance | £11,000* | £1,570** | |
| Dividend allowance | £500 | ||
| Starting rate savings band | £5,000 | ||
| Personal savings allowance | £1,000 | ||
| Taxable income | £0 | £1430 @20% | £9500 @8.75% |
| Tax payable | £0 | £286 | £831.25 |
* Personal allowance is £12,570, so unused personal allowance is £1,570.
Next, we need to consider the savings and dividend income. The SRSB and PSA can be used. Therefore £5,000 and £1,000 (basic rate taxpayer) can be used against the savings income.
** As the taxable savings income is liable to 20% tax it is more beneficial to the individual to use the unused personal allowance against the savings income.
Examples |
||
Individual with the following income: |
||
| • Pension income | £30,000 | |
| • Savings income | £ 6,000 | |
| – Interest | £4,000 | |
| – Offshore bond gain | £2,000 | |
| • Dividend income | £10,000 | |
| Non-savings income | Savings income | Dividend income | |
| Pension income | £30,000 | ||
| Interest | £4,000 | ||
| Offshore bond gain | £2,000 | ||
| Dividend income | £10,000 | ||
| Personal allowance | £12,570 | ||
| Dividend allowance | £500 | ||
| Starting rate savings band | £0* | ||
| Personal savings allowance | £1,000 | ||
| Taxable income | £17,430 @ 20% | £5,000 @ 20% | £9500 @ 8.75% |
| Tax payable | £3,486 | £1,000 | £831.25 |
* SRSB reduced to zero as the non-savings income is greater than £17,570.
Individual with the following income: |
||
| • Pension income | £10,000 | |
| • Savings income | ||
| – Interest | £4,000 | |
| – Offshore bond gain | £2,000 | |
| – Onshore bond gain | £10000 | |
| • Dividend income | £10,000 |
| Non-savings income | Savings income | Dividend income | Savings income without tax credit |
Savings income with tax credit |
|
| Pension income | £10,000 | ||||
| Interest | £4,000 | ||||
| Dividend income | £10,000 | ||||
| Personal allowance | £10,000* | £2,570** | |||
| Dividend allowance | £500 | ||||
| Offshore bond gain | £2,000 | ||||
| Onshore bond gain | £10,000 | ||||
| Starting rate savings band | £4,000*** | £1,000*** | |||
| Personal savings allowance | £1,000 | ||||
| Taxable income | £0 @ 20% | £0 @ 20% | £6930 @ 8.75% | £0 @ 20% | £10,000 @20% less basic rate tax credit |
| Tax payable | £0 | £0 | £606.38 | £0 | £0 |
* Personal allowance is £12,570, so unused personal allowance is £2,570.
** As the taxable savings income is zero it is more beneficial to the individual to use the unused personal allowance against the dividend income.
*** £4,000 SRSB can be used against the bank interest with £1,000 against the offshore bond gain.
Points to Consider
- When calculating the £100,000 threshold for personal allowance, the whole bond gain is used.
- If an individual had capital gains, exceeding the annual exempt amount, these sit on top of the individual’s taxable income to determine whether capital gains tax is chargeable at 10% or 20% (18% or 24% if residential property). When determining whether the individual is a basic or higher rate taxpayer for capital gains tax, the annual equivalent (slice) of the chargeable event gain is used.
Planning considerations
- Make use of all available allowances in the most tax-efficient way
- Use a combination of tax wrappers to maximise available allowances
- When considering surrenders of both offshore and onshore bonds in the same tax year, consider all available allowances
This document is based on Canada Life’s understandings of applicable legislation, law and current HM Revenue & Customs practice as of April 2024. It is provided solely for general consideration. The information regarding taxation is based on our understanding of current legislation, which may be altered and depends upon the individual financial circumstances of the investor. We recommend that investors take their own professional tax advice.