What is the marginal tax rate? If you’ve ever asked this question and wondered how it affects your income, you’re not alone. The marginal tax rate is the percentage of tax you pay on the next pound of income you earn.

This matters because it helps determine how much extra tax you’ll pay when you earn more money – whether from a pay rise, overtime, or other additional income sources.

What is the marginal tax rate?

The marginal tax rate is the rate at which your last pound of income is taxed. It’s a key feature of a progressive tax system, which means that as your income increases, you pay a higher tax rate on the additional income. For example, if you earn more than a certain threshold, the income above that threshold is taxed at a higher rate than your previous income.

How does the marginal tax rate work?

Let's break it down with an example. Imagine your income falls into the UK’s tax bands, and you earn £40,000 a year. The first £12,570 might be tax-free (due to your personal allowance), the next portion taxed at 20%, and so on.

If you get a raise of £5,000, only that extra £5,000 is taxed at the higher rate – not your entire income. This is the beauty of the marginal tax rate; only the income that falls into each specific tax bracket is taxed at the respective rate.

Marginal tax rate vs. average tax rate

The marginal tax rate applies to the last portion of your income, whereas the average tax rate is the overall percentage of your total income that you pay in taxes.

For example, if your total income is £40,000, and after deductions you pay £6,000 in tax, your average tax rate is 15%. However, if your last £1,000 of income is taxed at a higher rate (say, 40%), that’s your marginal tax rate.

Why does the marginal tax rate matter?

Your marginal tax rate has a big impact on your take-home pay. When you earn more money, understanding how much extra tax you'll pay can influence your decisions. For instance:

  • Overtime or bonuses: Knowing how much extra tax will be deducted might make you think twice about taking overtime or accepting a bonus.
  • Second job: If you take on a second job, understanding your marginal tax rate helps you know how much of that income will be taxed.
  • Investment income: Extra income from investments can also be taxed at a higher rate, depending on your marginal tax rate.

Marginal tax rate in the UK: An overview

For the 2025-2026 tax year, the UK income tax bands are as follows for England, Wales, and Northern Ireland:

  • Personal allowance: Up to £12,570 – tax-free.
  • Basic rate: Up to £37,700 – taxed at 20%.
  • Higher rate: From £37,701 to £125,140 – taxed at 40%.
  • Additional rate: Above £125,140 – taxed at 45%.

In Scotland, the tax bands are different:

  • Personal allowance: Up to £12,570 – tax-free.
  • Starter rate: Up to £2,827 – taxed at 19%.
  • Basic rate: From £2,828 to £14,921 – taxed at 20%.
  • Intermediate rate: From £14,922 to £31,092 – taxed at 21%.
  • Higher rate: From £31,093 to £62,430 – taxed at 41%.
  • Advanced rate: From £62,431 to £125,140 - taxed at 45%
  • Top rate: Above £125,140– taxed at 48%.

These tax bands are important to understand, as they can impact how much tax you pay depending on your income level. Knowing your marginal tax rate helps you plan your finances and make informed decisions about saving and investing.

Examples of marginal tax rate in action

  1. Employee Raise: If you earn £45,000 a year and receive a £5,000 raise, you’ll be pushed into the higher tax band. Only that additional £5,000 will be taxed at 40%, not your entire £45,000.
  2. Rental Income: If you earn rental income, it gets added to your overall income. If this extra income pushes you into a higher tax bracket, the income over the threshold will be taxed at the higher rate.

The marginal tax trap: losing allowances

Crossing certain income thresholds can result in losing valuable allowances. For example:

  • Personal allowance: If you earn over £100,000, your personal allowance starts to shrink. This means more of your income is taxed.
  • High Income Child Benefit Charge: If your income exceeds £50,000, you might have to repay some or all of the child benefit you receive.

These ‘marginal effects’ can significantly reduce your take-home income.

Marginal tax rate vs. effective tax planning

Managing your marginal tax rate is key to effective tax planning. Here are a few strategies:

  • Maximise pension contributions: Contributions to a pension plan can reduce your taxable income, potentially keeping you in a lower tax band.
  • Use ISAs: These are tax-efficient savings accounts that allow you to grow your savings without paying tax on the interest, dividends, or capital gains.
  • Claim allowances and reliefs: Be sure to make the most of any tax reliefs you’re eligible for, such as Marriage Allowance or Blind Person’s Allowance.

How marginal tax rate affects savings and investments

Understanding your marginal tax rate helps you optimise your savings and investments. For example:

  • Interest: Interest on savings is taxed at your marginal tax rate. Higher earners pay more tax on the same interest income.
  • Dividends: If you earn dividends from investments, those are taxed at different rates depending on your income level.
  • Capital Gains: The tax rate on capital gains depends on whether you’re in the basic or higher tax band.

Understanding your marginal tax rate

In short, your marginal tax rate is the rate at which your additional income is taxed. Understanding this rate can help you make smarter financial choices, whether it’s about taking on more work, managing investments, or planning for the future.

If you're looking for help with tax refunds or navigating your tax situation, Rift can provide the support you need to maximise your tax return. Don’t hesitate to get in touch and let us help you get back what you’re owed.