Income tax on savings and investments
Tax on savings
By Chiara Cavaglieri
Article 2 of 4
Tax on savings
Learn how the personal savings allowance affects your tax bill and whether you need to pay tax on savings interest.
Since April 2016, there's been a new personal savings allowance. Interest on savings is tax-free, to a threshold of £1,000 for basic-rate (20%) taxpayers, and £500 for those who pay higher-rate (40%) tax. This will not apply to additional-rate taxpayers.
All interest from savings will be paid gross, which means tax will no longer be deducted by your bank or building society.
How does the personal savings allowance work?
HMRC has provided a few useful examples to illustrate how the allowance works in practice for basic and higher-rate taxpayers:
- You earn £20,000 a year and get £250 in account interest – you won’t pay any tax because it’s less than your £1,000 allowance.
- You earn £20,000 a year and get £1,500 in account interest – you won’t pay tax on your interest up to £1,000. But you’ll need to pay basic rate tax (20%) on the £500 above this.
- You earn £60,000 a year and get £250 in account interest – you won’t pay any tax because it’s less than your £500 allowance.
- You earn £60,000 a year and get £1,100 in account interest – you won’t pay tax on your interest up to £500. But you’ll need to pay higher rate tax (40%) on the £600 above this.
Tax on savings: claiming tax back
For taxed interest received between April 2015 and 2016, if you are a non-taxpayer, because your total income from all sources comes to less than your personal income tax allowance (£10,600 for the 2015/16 tax year), you can claim back tax that has been deducted by completing form R40 (available from HMRC), or a self-assessment tax return.
After April 2016, tax will no longer be deducted at source – so claiming it back is no longer necessary.
Is any savings income covered by the allowance?
The personal savings allowance applies to interest you earn from any non-Isa savings accounts, current accounts, government or corporate bonds, peer-to-peer lending interest, and interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts.
Individual savings accounts (Isas) and National Savings and Investments (NS&I) products don't count towards your allowance because they are already tax-free.
Can interest from savings push me into a higher tax bracket?
Yes, savings income within the allowance still counts towards the basic or higher-rate limits – and may therefore affect the level you’re entitled to and the rate of tax due on any excess income.
So, if you are a basic-rate taxpayer and you earn enough interest from savings to be pushed into the higher-rate tax threshold (which is £43,000 for 2016/2017), you are only entitled to a £500 allowance and will owe 40% tax on the remainder.
What if I exceed my allowance?
In most cases, any tax due will be collected automatically through the pay-as-you-earn (PAYE) system, using information provided by banks and building societies. You should be issued with a 'notice of coding' if this is the case.
Or, it can be declared on a self-assessment tax return as normal if you usually complete one.
Under long-term plans to transform the current tax system, interest could eventually be processed directly from individual digital tax accounts.
Extra tax break for low earners
In addition to the personal savings allowance, an extra tax break already helps those on a low income pay either no tax or reduced tax on their savings.
This £5,000 ‘starting rate for savings’ means anyone with total taxable income under their personal income tax allowance plus £5,000 will not pay any tax on your savings.
This means if your total taxable income is less than £17,000 for 2016/17, you won’t pay any tax on their savings. It helps to think of these allowances sitting on top of each other; first the personal allowance (£11,000 for 2016/17), then the £5,000 starting savings rate at 0%, and finally the personal savings allowance worth up to £1,000.
Other low earners can still benefit from this 0% starting rate on some of their savings income. For example, if you earn £13,000 a year from a part-time job and £4,000 interest from savings, this is how you would be taxed in 2016/17:
- 20% tax on £2,000 of your wages (£13,000 less the £11,000 personal income tax allowance)
- 0% tax on £3,000 of your savings (£5,000 starting rate limit, less the £2,000 over the personal income tax allowance)
- 0% tax on the remaining £1,000 of your savings using your £1,000 personal savings allowance
Does this mean Isas are pointless?
There are still significant long-term benefits to Isas, particularly if you're a high earner or you have substantial savings.
It's likely that the best way to boost returns and minimise tax is to combine a range of savings products and Isas, as well as high-interest current accounts if you don't mind switching banks.
Find out more: are Isas still worthwhile? – the pros and cons of saving in a cash Isa
- Last updated: October 2016
- Updated by: Chiara Cavaglieri