THE PERSONAL SAVINGS ALLOWANCE
From April 2016 a new Personal Savings Allowance will mean that most people can avoid tax on their savings interest. Most people can save up to £200 tax as a result of the changes. If you earn less than £16,000 including savings interest you could pay no interest on a further £5,000.
- You can save up to £200 interest per tax year using the personal savings allowance
- Your savings interest also starts at 0% for the first £5,000 income in certain circumstances
- Changes affect bank savings and fixed interest securities such as corporate bonds
- All interest will be paid gross (with no tax deducted)
- Examples to help you understand the new position
- You should still use your ISA allowance
How the personal savings allowance works
Savings interest attracts tax at your income tax rate. You add your savings interest to your other earned income and pay tax at 0%, 20%, 40% or 45% depending on your total income for the tax year.
From April 2016 all Basic Rate and Higher Rate income tax payers will get a new personal savings allowance, which will mean that a proportion of your savings interest will be tax-free.
- Basic rate (20%) income tax payers will have a tax-free allowance of £1,000
- Higher rate (40%) income tax payers will have a tax-free allowance of £500
- Additional rate (45%) income tax payers will have no personal savings allowance
Imagine you have £100,000 in a bank account, which pays 1% annual interest. The total income before tax would be £1,000 for the tax year.
Before April 2016
- 0% tax payers pay no tax on this income
- 20% tax payers pay £200 on this income
- 40% tax payers pay £400 on this income
- 45% tax payers pay £450 on this income
After April 2016
- 0% tax payers would not be affected – you still pay £0 tax on this income
- 20% tax payers would pay no tax on income up to £1,000, and therefore save £200 in tax. Your total tax would be £0.
- 40% tax payers would pay no tax on income up to £500, and pay 40% tax on the remaining £500, saving £200 in tax. Your total tax would be £200.
- 45% tax payers would pay the same rate of income tax as previously – £450
Accounts affected by the personal savings allowance
This change applies to all accounts that pay interest:
- Bank accounts
- Building society accounts
- Guaranteed bonds
- Peer-to-peer lending
- Fixed interest securities, such as corporate bonds or gilts
This change does not affect other income such as dividends from shares, although further changes have been announced in this area. Tax-free accounts such as ISAs and some National Savings are not affected.
0% starting rate for savings
You can also receive additional savings interest at 0% tax if your total income from non-savings sources is less that £16,000. Therefore, the maximum tax-free savings under the 0% starting rate is £5,000.
- If your non-savings income is greater than £16,000
You cannot claim this additional allowance.
- If your non-savings income is less than £16,000
You deduct the non-savings income from £16,000. The remaining savings interest is the amount you can claim at 0% tax, up to £5,000. You can also claim the £1,000 personal savings allowance on top.
We understand that this is complicated, but we did not make the rules!
How interest will be paid after April 2016
The changes introduced by the personal savings allowance mean that from April 2016 all interest will be paid gross – before tax. You must then account for any tax due via your tax return, or by an amendment to your tax code. This will simplify reporting in savings and investments.
Joint accounts will typically split interest between both parties, so bear this in mind if one of you is a basic rate tax payer and the other is a higher rate tax payer. You might be better off if you switch the account to the basic rate tax payer.
How the personal savings allowance works in practice
You will calculate the amount of earned income, and add any savings income to this to see whether you change tax band. If the savings income takes you into the next tax band, then this will reduce the personal savings allowance. Therefore:
- If your earnings are in the 0% income tax band, but your savings interest takes you into the 20% band, you would get a personal savings allowance of £1,000. Any interest over £1,000 would be taxed at 20%
- If your earnings are in the 20% income tax band, but your savings interest takes you into the 40% band, you would get a personal savings allowance of £500. Any interest over £500 would be taxed at 40%
- If your earnings are in the 40% income tax band, but your savings interest takes you into the 45% band, you would lose your personal savings allowance. Any interest would be taxed at 45%
John earns £11,000 from his job. He gets £6,000 savings interest. He pays no income tax on his earnings due to the income tax personal allowance. He pays no income tax on his savings due to the 0% starting rate for the first £5,000 savings interest. He can then use the £1,000 personal savings allowance to pay no income tax on the remaining savings interest. John’s total income tax is £0.
Jane earns £15,000 from her job. She gets £6,000 savings interest. She pays no income tax on the first £11,000 of earnings due to the income tax personal allowance; she pays income tax at 20% on the next £4,000 of earnings. She pays no income tax on £1,000 or her savings due to the 0% starting rate for the first difference between £16,000 and £15,000 earned income. She can then use the £1,000 personal savings allowance to pay no income tax on the next £1,000 savings interest. This leaves £4,000 savings interest taxed at 20%. Jane’s total income tax is £1,600.
You might conclude from this new allowance that there is no need to use your ISA allowance if you only have bank savings or corporate bonds in your ISA. While the need for the tax-free ISA is reduced, you may still get the benefits from the ISA if your interest is greater than the personal savings allowance. Also, ISAs allow you to avoid all capital gains tax, which would be useful if you have corporate bonds (or shares). Finally, legislation could always change again, so it makes sense to use your ISA allowance even if there is no obvious benefit at the moment.
The changes do mean that in most cases you would be better off using your ISA allowance on shares rather than cash. This is because the long-term growth on shares tends to be greater.
How we will report to clients on the new personal savings allowance
In your annual Investment Management and Financial Planning service reports we already report on the expected tax due. We will adapt our reports to show the expected tax due and any savings as a result of the changes.
What to do next
If you have savings affected by the personal savings allowance you should review your position to assess if any tax savings can be made. Contact us to discuss your savings.
Find out how we can help you to Prosper during retirement.
Find out how we can help you to Prosper from your savings.
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