The Personal Savings Allowance is at the forefront of everyone's minds at the moment, particularly given that it's coming into force in just a week's time. But just what is this allowance, and how could it benefit you? We take a closer look…
The Personal Savings Allowance will allow you to earn up to £1,000 in interest each year without paying tax on it, with the level you get determined by your tax status. Basic rate (20%) taxpayers get the full personal savings allowance of £1,000, while higher rate (40%) taxpayers can earn up to £500 in interest tax-free, but additional rate (45%) taxpayers don't get an allowance.
Under the current system you'll be taxed on any interest you earn (unless you save into an ISA, which is already tax-free) based on your nominal rate, which means that basic-rate taxpayers will lose £20 in tax for every £100 interest earned, while higher-rate taxpayers will lose £40.
The personal savings allowance is therefore a dramatic shift from the norm, and means that most people will need a very healthy savings pot before they hit the tax-paying threshold – particularly given typical savings rates at the moment. For example, if you're a basic rate taxpayer and saved into an easy access deal paying 1%, you could have £100,000 saved and still not pay tax on the interest!
Indeed, it's estimated that it'll take 95% of taxpayers out of savings tax altogether, so the move is being welcomed by many. It applies to interest you earn from just about all types of account, too, whether it's a savings account, high interest current account, credit union account or even income from Government or corporate bonds (see the Government's fact sheet for more details). ISAs aren't included as income earned is already tax-free, and nor is dividend income from shares, but these are the main exceptions.
The new rules come into effect from 6 April 2016. As yet there's no confirmation of whether it'll be an indefinite change or a short-term arrangement, but we'll keep you posted if we hear anything.
Nothing! From next week, your bank or building society will pay all interest to you gross, without deducting tax first (as is the current system). There are no forms to fill in and no need to tell your bank anything at all – it's all done behind the scenes, so you don't need to lift a finger.
The only caveat to this is if you earn interest that's over and above your allowance. HMRC will want the tax that's owed to them, but this should be fairly straightforward, too: in this case, HMRC should collect the tax due by changing your tax code, with banks and building societies providing the necessary information they need to do this. However, if you're self-employed or fill in a self assessment tax return for any other reason, you'll continue to pay your tax in this method.
Many people could be questioning if they'll still need a cash ISA when interest they earn in any other account will be tax-free, too. Unfortunately, it's this uncertainty that has arguably led cash ISA rates to fall dramatically in recent months as people shy away from these accounts – but this could be a big mistake.
For starters, there's no guarantee that the personal savings allowance will last forever. This means that, if it were to be withdrawn in future, all of your savings held in non-ISA accounts would become liable for tax again – and you'd only be able to transfer a small portion of it into an ISA to shield it. This isn't the case with ISAs, where everything you save is tax-free for life.
Then there's the fact that interest earned from an ISA doesn't count towards your personal savings allowance, so if you're lucky enough to already have a big enough savings pot that would mean you hit your limit, you can still save in an ISA for more tax-free benefits. An ISA isn't dependent on tax status, either, so if you were to become a higher or additional rate tax-payer in the future, you wouldn't lose out on tax efficiency.
And what if savings rates rise? The current landscape means that you'd need a hefty savings pot before you paid tax, but if rates were to increase, your tax-free savings potential would diminish. Let's go back to the easy access example: today's typical rates may be around the 1% mark (or higher in our best buys), but if they rose to 4% (you never know!), anything above £25,000 would become liable for tax – and if rates were even higher, such as on fixed rate bonds, you could save even less.
Essentially, this means that you shouldn't turn your back on ISAs just yet, because they still offer valuable, long-term tax efficiency. Nonetheless, the personal savings allowance remains a huge boost for savers, giving them the chance to earn tax-free interest across a range of savings, banking and investment products, and you've got less than a week until you can benefit!
Compare savings accounts to find the best home for your tax-free money
See if you can get a better deal with a cash ISA
Check out the best high interest current accounts
Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.
Moneyfacts.co.uk will, like most other websites, place cookies onto your computer’s
hard drive. This includes tracking cookies.