Order of Taxing Income

Here, we look at the order in which multiple sources of income are taxed. This article is particularly relevant to the CII CF1, R03, R06, AF1, AF4, and AF5 exams.

This article is relevant to examinable tax year 2023/24 and is correct as at 2 March 2024.

Order of taxing income

Income is taxed in the following order:

• Non-savings;
• Savings;
• Dividends; and
• Chargeable gains under investment bonds 

Non-savings income

Non-savings income is taxed first and includes:

• earnings from employment (including bonuses, commission, tips);
• net profit from self-employment (i.e. profit after allowable expenses);
• pension income (including the State pension, occupational pensions and personal pensions);
• taxable State benefits;
• rental income (unless exempt under the property allowance or rent a room relief); and
• trust income.

In the current examinable tax year, once an individual’s non-savings income exceeds their personal allowance (usually £12,570 but can be less for high earners), then it is taxed as follows:

You should be aware that different rates apply in Scotland for non-savings income; although, these rates are not examined by the CII.

 Savings income

Savings income is next. This includes interest from bank and building society accounts, gilts, local authority and corporate bonds, collective investments that invest primarily in fixed-interest investments and purchased life annuities.

Savings income that falls into the basic, higher and additional rate tax bands is taxed at the same rates as for non-savings income outlined above.

However, where savings income falls within the first £5,000 of a taxpayer’s taxable income, the starting rate of 0% applies.

Basic rate taxpayers benefit from a personal savings allowance of £1,000. Taxable savings income that falls within this allowance is charged to tax at 0%.  Higher-rate taxpayers also benefit from a personal savings allowance. However, their allowance is just £500. Additional rate taxpayers do not benefit from a personal savings allowance.

Some savings income is still paid net of the basic rate tax of 20% so we need to gross this up to work out the total interest that has been paid and whether any tax can be reclaimed, when dealing with non-taxpayers or taxpayers within the starting rate band or, for higher and additional rate taxpayers, how much extra tax is due.

To gross up a net interest payment we divide it by 0.8.

For example, if Archie receives a net interest payment of £80, to work out the gross interest we divide £80 by 0.8. This gives us a gross figure of £100. Any subsequent tax treatment will be as follows:

Dividend income

Next, we have dividend income. All taxpayers benefit from a £500 dividend allowance. Taxable dividend income falling within this allowance is charged to tax at 0% Thereafter, the position is as follows:

Chargeable gains under investment bonds

Finally, under savings income, any chargeable gains under investment bonds are added into the tax computation, with the tax charge being applied at 20% or 25% for gains falling within the higher and additional rate tax bands respectively. For onshore bonds, basic rate tax is deemed to have been paid in the fund and so satisfies the basic rate tax liability. No reclaim is possible for non-taxpayers, although top-slicing may reduce the amount payable at the higher rates.

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