Tax-free savings were changed; introducing a new personal savings allowance on April 6, 2016. According to the Personal Savings Allowance (PSA), which was implemented, the vast majority of savers in the UK no longer pay tax on their savings income. This ‘personal savings allowance’ has allowed individuals in the UK to grow their money and earn interest in their savings tax-free since its implementation. This article will provide an up-to-date guide on how this allowance works.
Tax-free Savings Allowance In The UK
Your personal savings allowance (PSA) in the UK is a tax-free allowance that allows you to earn interest on your savings without having to pay taxes on it. Your income tax rate determines the amount of your allowance. For basic rate taxpayers (20%), Savings interest of £1,000 per year can be earned tax-free in the allowance. While higher-rate (40%) taxpayers can earn £500 in savings interest each year without paying any tax. £0 (no allowance) for additional-rate (45%) taxpayers.
With PSA, more than 95% of savers do not pay any tax on their savings interest. The PSA covers interest on bank, savings, credit union, building society, corporate, government, and gilt accounts. And Interest earned on other currencies (e.g., US dollars, euros) kept in UK-based savings accounts is also inclusive.
Furthermore, interest on peer-to-peer loans is covered as well, although dividend income from stocks or funds is not (there’s a separate allowance for that). But, Interest payouts from permitted unit trusts, open-ended investment firms, and investment trusts, as well as most types of purchased life annuity payments, are included in the PSA (but not dividend distributions).
Note: The tax income criteria and rates alter slightly if you live in Scotland. However, taxable savings income, such as bank interest and dividends, will be taxed at UK rates for the 2021/2023 tax year.
How Does Tax-free Savings Allowance Work?
HMRC has provided a few examples of how the allowance works in practise for both basic and higher-rate taxpayers:
You earn £20,000 per year and receive £250 in account interest; you will not pay tax because the amount is less than your £1,000 tax allowance.
If you make £20,000 a year and receive £1,500 in account interest, you won’t have to pay tax on the first £1,000 of your interest. On the £500 above that, you’ll have to pay a basic rate tax (20%).
You earn £60,000 per year and receive £250 in account interest; you will not pay tax because the amount is less than your £500 tax exemption.
If you make £60,000 a year and earn £1,100 in account interest, you won’t have to pay tax on the first £500 of your interest. However, on the £600 beyond this, you’ll have to pay a 40% higher rate of tax.
Tax-free Allowance On Savings Interests
Savings interest from your bank or building society is frequently paid ‘gross’, meaning that it is not subject to taxation, even though it, like any other form of income, is normally taxable. The maximum amount of interest you can earn tax-free is shown below.
| Your rate of tax | Salary income is not from savings | Amount of interest on savings that are tax-free |
No tax | £0 to £12,570 | With the starting rate for savings, you can earn a maximum of £5,000 in interest tax-free. |
Basic rate taxpayer – low income | £12,571 to £17,570 | With the starting rate for savings, you can earn up to £5,000 in interest tax-free. With the Personal Savings Allowance, they can earn up to £1,000 in additional interest on their savings tax-free. |
Basic rate taxpayer | £17,571 to £50,270 | The Personal Savings Allowance allows you to earn £1,000 in interest on your savings without paying tax. |
Higher rate taxpayer | £50,271 to £150,000 | The Personal Savings Allowance allows you to earn up to £500 in interest tax-free. |
Additional rate taxpayer | Over £150,000 | No savings and interest allowance |
Any interest earned on savings that exceeds your Personal Savings Allowance or Savings Starting Rate will be taxed. The amount of tax you pay is dependent on your income.
Also:
If you work or have a pension, HMRC will modify your tax code so that you automatically pay the tax. HMRC determines your tax code by estimating how much interest you’ll receive in the current year based on how much you received in the prior year.
More so, If your income from savings and investments exceeds £10,000, you must register for self-assessment. If you’re unsure, check to see if you need to file a tax return. Whether you’re unemployed, don’t have a pension, or didn’t file a self-assessment, your bank or building society will report to HMRC how much interest you earned at the end of the year. HMRC will inform you whether or not they require you to pay taxes and how to do so.
Report any interest earned on savings to HMRC if you’ve completed the self-assessmentment tax return.
Tax-free Savings
Some savings products pay tax-free interest regardless of how much you earn or what other savings interest you have. Because of the Personal Savings Allowance, most savers no longer need to put money into an ISA to get tax-free interest.
In the UK if you are an extra rate taxpayer, your ISA allowance for the 2021/23 tax year is £20,000, which means you can still have savings tax-free.
Examples of tax-free savings products are:
- ISAs
- Other national savings investments (NSI) products
Are Individual Savings Accounts ISA Still Worthwhile?
The value of ISAs has waned since the PSA was implemented, as most people no longer have to pay tax on savings income received outside of an ISA.
If you invest in stocks and shares, you can take advantage of the Dividend Allowance, which allows you to receive up to £2,000 in dividend income tax-free each year. If you invest outside an ISA and exceed this threshold, you will be taxed at a rate of 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for extra rate taxpayers.
The PSA and Dividend Allowance, however, do not make ISAs obsolete, and they should still be considered as part of your overall savings and investment portfolio.
Does Individual Savings Account (ISA) Count As Savings Income?
Your Personal Savings Allowance is not affected by ISA income. As a result, you can earn tax-free interests while also taking advantage of the full £1,000 Personal Savings Allowance in the UK.
The following items are also not included in your Personal Savings Allowance:
- Any savings income that isn’t taxed because of a saver’s Personal Allowance or the 0% rate for savers with lower earnings.
- Dividend distributions (the Dividend Allowance covers these separately). More information can be found here.)
- Account incentives that aren’t based on interest or savings return
Are all savings income covered by the personal savings allowance?
Interest earned on non-Isa savings and current accounts counts toward your personal savings allowance.
There are notable exceptions, such as Individual Savings Accounts (ISAs) and some NS&I savings products, such as premium bonds. Because they are already tax-free, they are not covered by the personal savings allowance.
Some investments are also eligible for the personal savings allowance. You can utilize your personal savings allowance to offset interest collected from the following sources:
- Bonds issued by the government or corporations
- Interest in peer-to-peer lending
- interest distribution eg income from bond funds, licensed unit trusts, open-ended investment companies, and investment trusts.
In summary, the underlying investments determine whether your investment income is taxed as savings or as a dividend.
Earnings from loan-based investments, such as the ones mentioned above, will be taxed as interest, whereas profits from equity investments (purchasing stock in companies) would be taxed as dividends.
Rental property profits are taxed in the same way that work and pensions are.
Savings Starter Rate
In addition to the personal savings allowance, persons on a low income already benefit from an additional tax incentive that allows them to save tax-free or at a reduced rate. You may be eligible to receive up to £5,000 in interest without paying tax on it. This is the rate at which you should begin savings.
- Your beginning rate for savings will be lower the more you receive from other sources of income (such as your salary or pension).
- If you earn £17,570 or more in other ways- If your other income is £17,570 or more, you won’t be eligible for the starting rate for savings.
- Your starting rate for savings is £5,000 if your other income is less than £17,570. Your beginning rate for savings is reduced by £1 for every £1 of other income beyond your Personal Allowance.
Tax-free Savings Allowance On Joint Account
Your Personal Savings Allowance still applies if you share a joint savings account with someone. Joint accounts are taxed equally, 50% of the account’s interest is applied to your personal Personal Savings Allowance and another 50% to the other account holder.
However, Savings in shared bank accounts, are more complex, and HMRC recommends contacting them to report the savings income of interest, if applicable.
How To Claim Back Tax I Have Paid On Another Savings Income
Fill out an R40 form (or an R43 if you live overseas) and return it to HMRC to claim back any tax that was wrongfully deducted.
On the gov. UK website, you can find self-assessment tax return forms. It’s critical to remember to finish your self-assessment before the deadline. It usually takes 6 weeks to receive the tax refund.
FAQs
Is the first 1000 of savings interest tax-free?
Earn up to £1,000 savings interest tax-free
Less than 5% of people in the UK pay tax on their savings interest due to the personal savings allowance (PSA), which lets most people earn up to £1,000 in interest without paying tax on it.
How much savings can I have without paying tax?
You may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings. The more you earn from other income (for example your wages or pension), the less your starting rate for savings will be.
Do I pay tax on savings if retired?
Tax on your savings
The way your savings are taxed doesn’t change when you retire or reach State Pension age. Banks and building societies now pay savings interest without any tax taken off but, depending on your situation, you may still have to pay tax on some of your savings income.
Do HMRC do random checks?
HMRC carries out compliance checks on a proportion of returns to check their accuracy. Some checks will be completely random, while others will be made on businesses operating in ‘at risk sectors or where prior risk assessments have been conducted.
