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How are my savings taxed?

Category: Savings
Author: Tim Leonard
Updated: 18/01/2019

At a glance:

  • Basic rate taxpayers can earn £1,000 in savings interest every year without paying tax, while higher rate taxpayers can earn £500.
  • Money in an ISA will not be taxed, but there may be tax implications once you transfer the money to a non-ISA account.
  • If you do need to pay tax on your savings, you will need to contact HMRC yourself.

Every basic rate taxpayer in the UK currently has a Personal Savings Allowance (PSA) of £1,000. This means that the first £1,000 of savings interest earned in a year is tax-free and you only have to pay tax on savings interest above this. Note that if you are a higher rate taxpayer (40%), your allowance is £500, while 45% taxpayers have no tax-exempt savings allowance at all.

Be careful, however, as it's not just your savings at the bank or building society you have an account with that count towards your £1,000 interest amount. If you own corporate bonds or Government gilts that also pay interest, this will be included. Additionally, 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 total allowance.

Low income earners can also benefit from a 0% 'starting rate' of income tax for up to £5,000 of savings interest. This reduces for every £1 you earn over the Personal Income Tax Allowance of £11,850 (2018/19 tax year). So, if you earn £12,500, your 0% starting rate for savings would be a maximum of £4,350 (£5,000 allowance less £650 over your tax allowance).

If your overall taxable income (from employment plus your savings interest) is £17,850 or less, you may not need to pay tax on your savings income. This amount is made up of your annual Personal Income Tax Allowance, plus the 0% rate for £5,000 of savings income, plus the £1,000 new Personal Savings allowance. Your income would need to be exactly the same as the Personal Income Tax Allowance to get the full £17,850 benefit.

As this is very complicated, the following examples should help:

  • If you earn £10,000 from employment plus £5,000 in savings interest, no income tax will be payable at all. The employment income is less than the £11,850 personal income tax allowance, and the savings income is within the 0% starting rate for savings;
  • If your income from employment was £13,000, and your savings interest was £3,000, you would need to pay 20% tax on £1,150 of earned income (anything over the £11,850 personal income tax allowance), but your savings income would be tax-free under the starting rate for savings.
  • If you earn £16,000 from your job and £1,000 from savings, you would pay 20% tax on £4,150 of income. The savings income would be tax-free as £850 would be charged at the 0% starting rate for savings and £150 would be within the personal savings allowance.

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).

Income Tax Rates
Basic Tax Rate 20%
Higher Tax Rate 40%
Additional Rate 45%

A crucial change since April 2016 is that your savings interest will be paid gross, i.e. without tax having been deducted. This means 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 2018/19 tax year.

Tax on a stocks & shares ISA

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 2018/19 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 £2,000 in income without paying tax on it. Dividends above this amount will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers or 38.1% for additional rate taxpayers.

Tax on an investment bond

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%).

What next?

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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.