Income tax on savings and investments
Tax on savings
By Chiara Cavaglieri
Article 2 of 5
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, savers have been able to grow their money tax free, thanks to the 'personal savings allowance.'
This allowance allows you to earn interest up to £1,000 interest tax-free if you're a basic-rate (20%) taxpayer, or £500 if you're a higher-rate (40%) taxpayer.
Additional-rate taxpayers don't receive a personal savings allowance.
All interest from savings will be paid gross, which means tax will no longer be deducted by your bank or building society.
- Get a head start on your 2016-17 tax return with the Which? tax calculator. Tot up your tax bill, get tips on where to save and submit your return direct to HMRC with Which?.
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.
Is all savings income covered by the personal savings allowance?
The personal savings allowance applies to interest you earn from any non-Isa savings accounts and current accounts.
It also applies to some investments, too. You can use your personal savings allowance against interest earned from:
- government or corporate bonds,
- peer-to-peer lending interest,
- interest distributions, i.e. income from bond funds, from authorised unit trusts, open-ended investment companies and investment trusts.
This allowance can't be used for dividend income.
Individual savings accounts (Isas) and some 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 2016-17 and £45,000 in 2017-18 for most of the UK but £43,000 for Scottish taxpayers), you are only entitled to a £500 allowance and will owe 40% tax on the remainder.
What happens if I exceed my personal savings 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 £17,500 for 2017-18, 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 (£11,500 for 2017-18, £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 2017-18:
- 20% tax on £1,500 of your wages (£13,000 less the £11,500 personal income tax allowance)
- 0% tax on £3,500 of your savings (£5,000 starting rate limit, less the £1,500 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: April 2017
- Updated by: Tom Wilson