What is the personal savings allowance?
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, so if you earn more than £150,000 each year, you’ll need to pay tax on all your savings.
All interest from savings will be paid gross, which means tax will no longer be deducted by your bank or building society. Our video explains how it works.
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.
There are exceptions – namely Isas and some NS&I savings products, such as Premium bonds. These aren’t covered by the personal savings allowance, because they are already tax free.
The personal savings allowance 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.
In a nutshell, whether your investment income is taxed as savings or as a dividend depends on the underlying investments.
Income from loan-based investments, including the above, will be taxed as interest, while profits from equity investments (buying shares in companies) are taxed as dividend income.
Profit from rental properties is taxed in the same way as work or pensions income.
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, you are only entitled to a £500 allowance and will pay 40% tax on the remainder.
In 2019-20, the higher-rate tax threshold in most of the UK is £50,000, up from £46,350 in 2018-19.
In Scotland, the higher-rate threshold works slightly differently. You pay 41% income tax on income above £43,430 in 2019-20, unchanged from 2018-19.
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.
- Submit your 2018-20 tax return: to tot up your bill and send your tax return direct to HMRC, use the Which? tax calculator.
What if I've paid too much tax on my interest?
You can reclaim tax paid on your savings interest, if your bank or building society didn't make use of your full personal savings allowance.
Fill in form R40 to claim the tax you were wrongly charged. You can claim tax on savings from up to four tax years ago.
It'll normally take around six weeks to get your money back.
What is the 'savings starter rate'?
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 £18,500 for 2019-20, you won’t pay any tax on your savings.
It helps to think of these allowances sitting on top of each other; first the personal allowance (£12,500 for 2019-20), then the £5,000 starting savings rate at 0%, and finally the personal savings allowance worth up to £1,000.
When HMRC calculates the tax you owe, they’ll first look at your income from other sources, and then from your savings income.
So for example, if you earn £14,000 a year from a part-time job and £5,000 interest from savings, this is how you would be taxed in 2019-20:
- 0% on the first £12,500 income from your job = £0
- 20% tax on the remaining £1,500 from your wages (£14,000 less the £12,500 personal income tax allowance) = £300
- 0% tax on £3,500 of your savings (because you’ve lost £1,500 of the 0% savings band from your earnings over the personal allowance) = £0
- 0% tax on the remaining £1,000 of your savings using your £1,000 personal savings allowance = £0
- 20% tax on the remaining £500 savings interest = £100
Total tax bill = £400.
Does this mean Isas are pointless?
Even though there are now generous tax breaks on savings, and interest on non-Isa savings accounts tends to be higher, 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.
It’s also worth bearing in mind that the personal savings allowance will protect your interest from tax this year – but if you’re growing savings over the long term once they’re in your Isa they’ll be tax free forever.
Find out more: are Isas still worthwhile? – the pros and cons of saving in a cash Isa