Summary
Timeline Planning models employed income as gross
Employed income can be inflation-adjusted (fully adjusted to CPI) or not, with a 0% collar applied for inflation adjustment.
National Insurance and income taxes are computed based on current rates (for the tax year 2024/2025).
Description
This article will explain our modelling approach to employed income, how we compute national insurance and income taxes, and provide an illustrative example.
Modelling Employed Income in Timeline
In Timeline, employed income is treated as gross. We offer flexibility by allowing the employed income to be either inflation-adjusted (fully adjusted to CPI) or not. If inflation adjustment is chosen, we apply a 0% collar, meaning the income will never decrease during a deflationary period.
We compute national insurance and income taxes based on the most recent rates for tax purposes. As of the time of writing, the rates are up-to-date for the tax year 2024/2025.
Calculation of National Insurance and Income Tax
Step #1: National Insurance Contributions Tax
Timeline calculates the national insurance tax based on the annual income:
If the annual income is less than £12,570, the national insurance tax is £0.
For Class 1, if the annual income is between £12,570 and £50,270, any income above £12,570 up to £50,270 is taxed at 8%.
If the annual income exceeds £50,270, then £37,700 is taxed at 8%, and any income exceeding £50,270 is taxed at 2%.
Step #2: Income Tax and Total Tax
Next, Timeline computes the income tax based on the current rates and bands for the 2024/2025 tax year.
The total tax is then calculated by adding the national insurance tax and the income tax. This total tax amount is subtracted from the employed income to derive the net income that the taxpayer will receive.
Example
Consider John, who is employed and earns £100,000 a year. The first £12,570 of his income is tax-free. The next £37,700 is taxed at 8%, equating to £3,016, while the remaining £49,730 is taxed at 2%, amounting to approximately £995. Thus, John's total national insurance tax is £4,011.
John's income tax for the year is calculated as £27,432. Adding this to his national insurance tax yields a total tax of £31,443. Therefore, John's net annual income is £68,557 (£100,000 - £31,443).
Conclusion
In this real-life example, John's total tax liability for the year breaks down as follows:
National Insurance tax: £4,011
Income tax: £27,432
John's net income for the given year is £68,557. By accurately modelling national insurance and income taxes for employed income, Timeline Planning aids financial advisors in navigating the complexities of financial planning. We hope this article and its practical example have provided insight into this critical aspect of our cashflow modeling tool.