Tax On Your Savings Interest?
Over the last year or so interest rates on savings accounts have risen from their pitiful rates, which were often a fraction of 1%, and rates of 4% to 5% are now available on instant access savings. We are not authorised to point you towards a particular savings account, my reason for this article is to warn you of the possibility that you will have to pay tax on your savings interest for the tax year that we are currently in, which will end on 5 April 2024.
The government introduced the Personal Savings Allowance in 2016 which means that the first £1,000 of interest paid to basic rate taxpayers (gross income no more than £50,270) is not taxable. Interest still has to be reported if you fill in a tax return, but you don’t pay tax on it. If you are a higher rate taxpayer (gross income £50,271 to £125,140) the interest allowance reduces to £500 and if your income goes over £125,140 so that you are an ‘additional rate’ (45%) taxpayer you don’t get any interest allowance at all.
A couple of years ago if you were getting 1% interest on your savings you could have £100,000 in a savings account and your interest of £1,000 would be covered by the savings allowance. But if you are now earning 5% on your savings you only need £20,000 in savings for the interest to go above the savings allowance, or only £10,000 if you are already a higher rate taxpayer so receiving the reduced interest allowance.
So what to do? The easy thing to suggest is that you consider putting some savings into a Cash ISA, where you can add £20,000 each tax year, because the interest on a cash ISA (in fact the investment return on any type of ISA) does not need to be reported to HMRC. So long as the interest rate on the ISA is more than 80% of a comparable non-ISA account you will be better off, by which I mean that an ordinary savings account paying 5% gross where tax on the interest is 20% effectively pays you 4% net after tax. So a cash ISA paying more than 4% (not taxable) leaves you in a better position. And if you are a higher rate (40%) taxpayer your gross interest of 5% becomes 3% net after tax so any ISA paying more than 3% leaves you better off. And if your interest already exceeds the savings allowance any investment into a cash ISA will save reduce tax.
If you are married you might wish to transfer savings between you, or turn sole accounts into joint, so as to fully use spare income tax allowances or basic rate tax bands. But if you have substantial savings earning a respectable rate of interest you are going to end up paying tax.
Note that due to a historical quirk there is a “starting rate” for savings interest of 0% but this only applies for particular (and unusual) combinations of income, where all other income apart from interest and dividends is less than the income tax allowance of £12,570. I rarely see this in the tax returns that I prepare but it can happen.
Interest is reported to HMRC through a self assessment return, but if you are not within self assessment and your interest is above the savings allowance (either £1,000 or £500 if you are a higher rate taxpayer) you need to notify HMRC and they will include it in your tax code.