The marginal tax rate represents the proportion of tax applied to your additional income. Essentially, it indicates the tax percentage on the next pound you earn. For someone with an annual income of £60,000, their marginal tax rate could be 40%, meaning each additional pound earned is taxed at 40p.
The taxes you owe each year are influenced by:
- How much of your income is within your Personal Allowance (PA)
- The amount of your remaining income that falls within each tax bracket
Marginal tax rates play a crucial role by ensuring that individuals with lower incomes are taxed a smaller fraction of their earnings compared to those with higher incomes.
Income Tax Rates and Bands for 2023/24
Your specific marginal tax rate is determined by the tax band your income falls into, with possibilities including:
- 0% for incomes under £12,570
- 20% for incomes between £12,571 and £50,270
- 40% for incomes between £50,271 and £125,140
- 45% for any income above this range
Earnings over £125,140 lead to a phased loss of the tax-free personal allowance.
Marginal Tax Rate Example
Consider Jasper, a self-employed artist earning £55,000 yearly. Falling into the higher tax bracket, Jasper faces two marginal tax rates.
His Personal Allowance covers the first £12,570 tax-free. The next £37,700 of his income attracts a 20% tax, while the remaining £4,730 is taxed at 40%. Consequently, Jasper's total Income Tax amounts to £9,032.
Why Marginal Tax Rates Matter for the Self-Employed
For self-employed individuals, understanding your marginal tax rate is crucial. It helps anticipate the additional tax due with increased earnings. Since freelancers and sole traders manage their taxes via Self Assessment, calculating the necessary savings for their annual tax bill is vital. Knowing your marginal tax rate aids in accurately estimating your tax liabilities when filing your return.
