Under tax rules prior to April 2016, any savings income you earned was potentially liable to income tax.
Tax of 20% was automatically deducted on certain savings income such as interest from bank and building society accounts and interest distributions from investment funds such as authorised unit trusts (AUTS) and Open Ended Investment Companies (OEICS). This meant basic rate taxpayers had no more tax to pay. However, higher rate taxpayers and those in the additional rate tax band, had to pay the extra tax they owed when they completed their annual self assessment tax return.
Non-taxpayers could arrange for bank interest on their current accounts and deposit accounts to be paid gross, so no tax was deducted, by completing an R85 form. This was the same for children’s savings.
The only way taxpayers could exempt themselves from paying tax on their savings income was by holding their money in an ISA.
So what’s changed?
A new Personal Savings Allowance (PSA) was introduced on 6 April 2016 which the government says means around 95% of savers no longer have any tax to pay on the interest they earn on their savings.
Basic-rate taxpayers qualify for a £1,000 PSA. This means they can receive up to £1,000 a year in savings income tax-free.
Higher-rate taxpayers, have a PSA of £500 a year, meaning they can earn £500 a year in savings income before they have to start paying tax on it.
Additional rate taxpayers do not receive a PSA and must pay tax on any savings income they receive on savings outside an ISA account.
As a result of the new PSA, the majority of savers in the UK no longer have to pay any tax on their savings income.
A basic-rate taxpayer for example, would only exceed the annual £1,000 PSA limit, if they had more than £100,000 in savings, assuming they were earning interest at a rate of 1.00% and earning no interest from other sources.
Based on the same rate of interest, someone in the higher-rate tax band would be liable for tax if their savings totalled more than £50,000.
Investors also have a Dividend Allowance, which means that individuals receive their first £2,000 in dividends tax-free, but any dividends above this amount will be charged at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
What happens if I do have to pay tax on my savings interest?
Since the introduction of the PSA, banks and building societies have stopped deducting 20% tax from bank interest, so it is now paid gross. Non–taxpayers no longer need to complete an R85 Form to receive their bank interest gross. However tax continues to be deducted automatically from certain other forms of savings income such as interest paid by a company that is not a bank.
HMRC has said that tax from savings income is collected via the Pay As You Earn (PAYE) system in the majority of cases. Some people may still have to declare it on their self-assessment tax return or pay it by other means, however. More information on this is available on the HMRC website.
In addition to interest on cash savings accounts, what else is classed as savings income?
The PSA applies to returns classed as savings income. This includes:
- Interest from bank and building society accounts
- Interest from accounts with providers such as credit unions and National Savings and Investments
- Interest distributions (not dividend) from AUTs, investment trusts and OEICs
- Income from corporate bonds and gilts (government bonds)
- Purchased life annuity payments
What does the Personal Savings Allowance mean for cash ISAs?
ISAs have become a hugely popular option for savers as returns on investments within an ISA are tax-free.
Now that the PSA has been introduced, the lure of ISAs is lessened as the majority of people no longer have to pay tax on savings income earned outside an ISA.
If you’re saving into stocks and shares, bear in mind that the Dividend Allowance means individuals can receive up to £2,000 each year in dividend income tax-free. If you exceed this threshold and hold investments outside an ISA, you will be taxed at a rate of 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
However, the PSA and dividend allowance do not mean ISAs are now redundant and they are still worth considering as part of your overall savings and investments portfolio.
Please remember the above is a guide only and Barclays does not provide tax advice. Tax rules can change in future and the effects of tax rules on you will depend on your individual circumstances, which, of course, can also change.
Please consult the HMRC website or a personal tax adviser for further detail.