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Do you understand the personal savings allowance?

Do you understand the personal savings allowance?

Category: Savings
Author: Leanne Macardle
Date: 09/03/2016

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

The personal savings allowance (PSA) comes into effect in just a month's time. It'll see the first £1,000 in savings interest become completely tax-free (£500 for higher rate taxpayers), but the question is, do you understand it? If research from AA Financial Services is anything to go by, you could be at a loss.

Confusion reigns

The research found that 90% of savers questioned don't know what the allowance is, and 49% are struggling to decide where to put their savings after April. The choice between cash ISAs and savings accounts appears to be causing the most confusion, with many people wondering whether they'll still need an ISA when the PSA comes into force.

In fact, 16% said that they'll only pay into a traditional savings account from April, while 7% said they'll actively move money out of their ISA and into a savings account – but is this a wise move?

"The personal savings allowance is good news for savers, but widespread confusion about what it means for people's money risks undoing the benefits," said Michael Johnson, director of AA Financial Services. "There will continue to be many differences between savings accounts and ISAs and the decision on what to do with your money isn't as simple as comparing rates between saving accounts and ISAs."

For starters, it's important to think on a longer-term basis. Achieving £1,000 in savings interest may seem like an impossible task at present what with being rates so low, but what if they were to rise in the future?

If you had an easy access account with a typical rate of 1% you'd need £100,000 in savings before any interest would be liable to tax, but if the rate went up to 3%, you'd earn £3,000 on that same savings pot – and £2,000 of that would face a tax charge. You'll want to think about your future circumstances, too, as a pay rise could affect the value of your PSA: if you went into a higher tax bracket your PSA would fall to £500, which could have a knock-on effect on your tax liability.

Then there's the fact that any money saved in an ISA will be tax-free for life, but there's no guarantee of how long the PSA will last for, so you may miss out on building a tax-free pot if you disregard ISAs altogether. And what about the ability to inherit ISAs? It all needs to be thought about!

"Relying on the PSA alone for your tax-free pot is a gamble," said Charlotte Nelson, finance expert at Moneyfacts. "Eventually rates will go up, and the amount savers can save tax-free will subsequently diminish.

"For this reason ISAs shouldn't be overlooked, particularly if you have larger amounts to save. In addition, ISAs can be passed on to spouses after death, which is worth contemplating when weighing up your long-term interests."

Provider uncertainty

However, it isn't just consumers who are confused by the whole thing – providers don't appear to be completely on the ball, either. There've been numerous reports of consumers trying to get clarification from their savings providers about what the changes will mean, only to be given vague details – and HMRC hasn't been much better.

As yet, there are no precise guidelines detailing how the changes will be implemented and how savers can avoid paying tax, and likewise, there's little to outline how those who earn interest above the PSA will need to pay their tax bill. However, it's hoped that the move will be fairly painless – savers are being told that they won't need to do anything in order to claim their allowance – and hopefully, the vast majority of savers will be able to benefit.

Happily, all the confusion hasn't put savers off, either, with 23% of respondents to AA's research expecting it to be easier to save over the next few months, so why not take advantage? By comparing savings accounts now you can make sure you're getting the best possible deal in time for the new allowance, whether you're opting for a traditional savings account, a cash ISA, or a combination of the two.

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.