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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. This means tax will no longer be deducted by your bank or building society.
Below are a few examples provided by HMRC that illustrate how the allowance works in practice for basic and higher-rate taxpayers:
The personal savings allowance applies to interest you earn from any non-Isa savings accounts and current accounts.
There are exceptions, which are Isa’s and some NS&I, savings products, such as Premium Bonds. The Personal Savings Allowance doesn’t cover these because they are already tax-free.
The Personal Savings Allowance can apply to some investments, too. You can use your personal savings allowance against interest earned from the following:
So 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.
Interest earned from savings can move you into a higher tax bracket. 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:
You are only entitled to a £500 allowance and will owe 40% tax on the remainder.
Most of the time any tax due will be collected automatically through the PAYE (pay as you earn) system, using information provided by banks and building societies. You should be issued with a 'notice of coding' if this is the case (see ‘understanding your tax code’).
Or, it can be declared on a SATR (self-assessment tax return as normal if you usually complete one.
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.
Even though we are seeing generous tax breaks on savings, and interest on non-Isa savings accounts tends to be higher, there are still significant long-term benefits to Isa’s, 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 Isa’s, 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 over the long term once they’re in your Isa your savings will be tax-free forever.