Although no changes were made to the personal savings allowance (PSA) threshold during the spring budget earlier this month, savers with high deposits still need to ensure that when the new tax year starts, they do not fall foul of the taxman.
The current PSA for basic rate taxpayers in the UK is £1,000. This means that the first £1,000 of savings interest earned in a year is tax-free, with tax only payable on interest above this. For those who are a higher rate taxpayer, their PSA is £500. Savers can find out more about PSA by reading our guide on how savings are taxed.
On top of this, savers also have a tax-free allowance depending on how much they earn and which tax bracket they fall into.
Those who earn £0 to £12,570 during the 2021/2022 tax year can earn up to £5,000 in interest on savings without having to pay tax.
Someone who earns £12,571 to £17,571 is a basic tax payer – low income and they can earn up to £5,000 in interest on their savings without having to pay tax. These savers can also earn a further £1,000 in interest through the PSA.
A basic rate tax payer is someone who earns between £17,5761 to £50,270. These savers can earn up to £1,000 in interest on their savings without paying tax through the PSA.
A higher rate tax payer is someone who earns £50,271 to £150,000 and they can earn up to £500 in interest on their savings through the PSA.
Someone who earns over £150,000 is considered an additional rate taxpayer. These savers have no tax-free savings allowance.
With saving rates at historic lows, many savers will not have to worry about paying tax on their savings, however those with high deposits or who are a higher rate taxpayer may find that interest earned on their savings pushes them above their allowance. It is important to remember that the PSA threshold applies to the total amount of savings held by an individual, not what is saved in individual savings deposits. For example, if a saver has £50,000 in one savings account, with a further £100,000 in a separate savings account, the PSA covers interest earned on the £150,000 in total.
With a PSA allowance of up to £1,000, combined with the low saving rates, basic taxpayers can save a significant amount before worrying about paying tax. Saying this, a saver with £170,000 in savings split across the highest-paying one year bond and five year bond will find that the interest made on their deposits will push them over the PSA limit.
For example, if a saver had £85,000 saved in a one year fixed rate bond offering 0.65% gross on maturity, this would result in them earning £552.50 in interest over the year. If they had a further £60,000 saved in a five year bond paying 1.30% gross on anniversary, this would result in them earning a further £780 over the one-year period. As such, this would result in them being £332.50 above their PSA.
Higher rate taxpayers have to be even more mindful about where they deposit their savings to avoid going over their PSA. For example, if a higher rate taxpayer had just £85,000 saved in a one year bond paying 0.65% gross on anniversary, they would earn £552.50 and already be £52.50 over their PSA threshold of £500.
Fortunately for savers wanting to save a high deposit but not go over their PSA limit, there are some options available.
One of the most common ways for savers to reduce their taxable saving each year is through using up their tax-free ISA limit. During the 2020/21 tax year, ISA savers can deposit up to £20,000 into a cash or stocks and shares ISA without having to pay tax on their savings. This £20,000 ISA limit will reset for the 2021/22 tax year, with the ISA tax-free allowance remaining at £20,000 for the new tax year, so after 6 April savers can deposit a further £20,000 tax-free into their ISA.
The higher rate taxpayer in the example above could reduce their taxable saving deposit if they deposited £20,000 of the £85,000 saved in a one year fixed bond into an ISA. This would result in just £65,000 in the one year bond, which at a rate of 0.65% gross would mean the interest gained would be £422.50 – below their PSA limit. Any interest earned on the £20,000 deposited into the ISA would be tax-free.
For the basic rate taxpayer in the example above, instead of depositing £60,000 into a five year bond, they could deposit £40,000 into the bond and the remaining into an ISA before the tax year ends. They could then deposit £65,000 into a one year bond and the remaining £20,000 into an ISA after the new tax year starts. This would reduce the amount of payable tax by £40,000 and, using the rates in the example above, would result in them earning £520 on the five year bond and £422.50 on the one year bond – a total of £942.50 in taxable interest.
Due to the ISA allowance being reset each tax year, ISAs also have the benefit of enabling savers to build up a significant amount of tax-free savings. Savers with ISAs should be careful when transferring funds between ISAs that they do it correctly to ensure they keep the tax-free status of their deposits. For more information about how to transfer ISAs, read our guide on ISA transfers.
Another tax-free option available to savers is the National Savings & Investment (NS&I) premium bonds. Although premium bonds do not guarantee interest and instead savers are put into a monthly draw where they can win tax-free cash prizes of up to £1 million, these accounts have the benefit of allow £50,000 to be deposited tax-free.
Clearly, savers looking to deposit a significant amount of savings need to think carefully about where they deposit their funds if they want to stay below their PSA limit. Moving funds across to ISAs will help savers to keep their deposits below the taxable threshold, as well as taking advantage of any other types of tax-free savings accounts such as NS&I’s premium bonds.
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