The way savings accounts are taxed fundamentally changed on 6 April 2016. Find out more.
Every basic rate taxpayer in the UK now has a Personal Savings Allowance of £1,000. This means that the first £1,000 of savings interest earned in a year is tax-free. If you are a higher rate taxpayer (40%), then your allowance is £500, and 45% taxpayers have no savings allowance at all. So, if you're saving at a rate of 2.5% (for example), you could save up to £40,000 and the interest would be free from tax.
This means you only have to pay tax on savings interest above your Personal Savings Allowance.
But be careful, because it's not just your savings at the bank or building society that count towards your £1,000 interest amount. If you own corporate bonds or Government gilts that also pay interest, this will be included. Also, if you invest in a unit trust or similar funds that pay what is called an 'Interest Dividend', or earn interest on a life insurance bond such as a with-profits bond, this too will count towards your allowance total.
Low income earners can also benefit from a 0% 'starting rate' of income tax for up to £5,000 of savings interest. If your overall taxable income (from employment plus your savings interest), is £17,500 or less, you will not pay tax on your savings income. This amount is made up of your annual Personal Income Tax Allowance of £11,500 (2017/2018 tax year), plus the 0% rate for £5,000 of savings income, plus the £1,000 new Personal Savings allowance.
As this is very complicated, the following examples should help:
If you do need to pay tax on your savings, the amount of tax you pay depends on your tax rate - and your tax rate is determined by the type of income and how much of it you receive every tax year (6 April to the following 5 April).
A crucial difference after April 2016 is that your savings interest will be paid gross, i.e. without tax having been deducted. It is now down to the individual saver to settle any tax payments they need to pay.
So if you earn over your Personal Savings Allowance in a tax year, you will need to inform HMRC in order to pay any tax due. They will normally do this by changing your tax code for the following year so that you can pay over the course of the year and not in a single lump sum.
Remember - you don't pay tax on interest you earn from a cash ISA regardless of the amount earned in interest. You can place up to £20,000 into a cash ISA in the 2017-18 tax year.
Interest earned on a stocks & shares ISA is also exempt from personal income tax and capital gains tax. The full allowance of £20,000 can be invested into a stocks & shares ISA in the 2017-18 tax year.
Currently, you don't need to declare any income or capital gains from an ISA to HMRC on your tax return.
Income from stocks & shares ISA funds that is paid as a dividend is paid totally tax-free. The dividend tax credit of 10% that used to be payable even within an ISA was abolished from 5 April 2016.
If you invest in shares or equity funds outside an ISA, you can now also earn up to £5,000 in income without paying tax on it. Dividends above £5,000 will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers or 38.1% for additional rate taxpayers. Note that this tax-free allowance will reduce to just £2,000 in April 2018.
The tax rules for 'qualifying' UK investment bonds allow up to 5% of the original capital to be withdrawn each year with no immediate tax liability. After 20 years, this could theoretically be 100% of the capital.
If you have used your 5% allowance every year, this will no longer be available to you. If you have not used your full allowance, this can be carried forward until 100% of the capital has been withdrawn.
If you make any further withdrawals after this, you will be taxed at an additional 20% for a higher rate taxpayer (as the fund where your money is invested is already taxed at 20%).
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Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.
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