Tax-free savings are changing: what you need to know about the personal savings allowance
The new tax year will bring some big changes to how your savings are taxed. From 6 April 2016, most people will no longer have to pay tax on the interest earned on money held in their bank or building society accounts.
This could have a huge effect on how you save and raises questions about whether individual savings accounts (Isas) are still worth bothering with.
What is the personal savings allowance?
From 6 April 2016, most of us will be given a personal savings allowance, which is an amount of interest we can earn on all our non-Isa cash deposits before income tax is due.
If you are a basic-rate income taxpayer, you can earn up to £1,000 in interest in a tax year before income tax needs to be paid. For higher-rate taxpayers, the allowance drops to £500 a year, but if you are an additional-rate taxpayer earning more
than £150,000 a year, you won’t get a personal savings allowance at all.
“The new personal savings allowance will be good news for most people, reducing tax for many and eliminating the need for low income individuals to claim a repayment for tax deducted from interest,” says ZoeRoberts, a partner at chartered accountant BHP.
What accounts does it apply to?
The new allowance covers interest earned from bank accounts, building society accounts, credit unions, corporate bonds, government bonds, gilts, and peer-to- peer lending.
The allowance will also apply to interest distributions from investment funds, investment trusts and most purchased life annuity payments.
But it does not cover dividends – a form of income that some companies pay out of their annual earnings to their shareholders. However, a new dividend tax allowance is also being introduced in April 2016. This will allow everyone to earn up to £5,000 in dividends tax-free each year.
The allowance doesn’t apply to interest earned in Isas or money won from Premium Bonds. These payments will still be tax-free and they will not count towards your annual personal savings allowance.
How do I claim my allowance?
You don’t need to do anything. From 6 April, banks and other firms that pay you qualifying interest will simply stop deducting income tax.
If tax is owed on your savings’ interest, HMRC says it will be taken via your tax code, so out of your wages.
If HMRC believes you will earn more savings interest than the savings allowance covers, your personal allowance – how much you can earn before income tax is due – will be lowered to reflect that interest. This will mean you’ll be given a different tax code.
The standard tax code is 1100L. If yours is different and you don’t know why, speak to HMRC (0300 200 3300) to check you aren’t paying more tax than you need to.
If you are self-employed, your savings’ interest will need to be declared on your self-assessment forms and tax paid accordingly.
Should I abandon my Isas?
If all your savings will earn interest tax-free anyway, it can seem as if Isas have become pointless. That isn’t the case.
“There are quirks and anomalies in the system that give Isas some hidden benefits,” says Danny Cox, a chartered financial planner at Hargreaves Lansdown.
The main benefit of an Isa is that the interest earned is tax free no matter how much the Isa grows. If you had fully invested in Isas every year since they started in 1999, you would have sheltered £163,320 from the taxman.
You could not protect that much money from tax simply by relying on your personal savings allowance.
If interest rates rise, you could find yourself paying tax on your savings income once you start earning more than the allowance. That doesn’t happen with money held in an Isa.
Ms Roberts adds: “As people’s incomes can fluctuate from year to year, investing in Isas may still have a benefit as it guarantees tax- free income rather than relying on a savings allowance, which may fluctuate between £1,000, £500 or nil each year.”
If you use your Isa to invest in the stock market, your gains will also be protected from capital gains tax (CGT). Abandon your Isa, and you will be liable for tax if your gains exceed the annual CGT allowance of £11,100.
Finally, interest earned on Isas doesn’t count towards your personal savings allowance. This means if you are approaching your personal savings allowance limit, move money into an Isa to avoid starting to pay income tax on it.
Make the most of both Isas and savings
Isas offer you long-term peace of mind that your money is safe from the taxman. But at the moment you can get better interest rates outside of the Isa wrapper.
The arrival of the personal savings allowance means you can take advantage of both. Build up your savings in a standard savings account paying the best interest rates – look at current accounts offered by Santander, TSB and Nationwide for the best rates.
Then if you’ve built up a sizeable savings pot, move some or all of it into an Isa to make sure it is free from tax long-term and the interest earned doesn’t affect your personal savings allowance.
First-time buyers stick to Isas
First-time buyers should be making the most of Help to Buy Isas before they consider using their personal savings allowance.
These special Isas come with good interest rates and the promise of a 25% government bonus when you are ready to buy your first home. This means you’ll get a much better return than a standard savings account – even if the interest rate is higher on the standard account.
However, the most you can save into a Help to Buy Isa is £200 a month (with an initial deposit of £1,000). If you want to save more than that, then the personal savings allowance means you can get a tax-free return on a standard regular savings account so you can save tax-efficiently in both.
How much money can I save before I max out the allowance?
The amount you can save depends on whether you pay basic- or higher- rate income tax. Be aware that the interest you earn could push you into a higher income tax bracket and therefore cut how much tax-free interest you can earn.
Here’s a table to show you how much you can save tax free, assuming you have no other savings:
|Best accounts||Basic-rate taxpayer||Higher-rate taxpayer|
|Easy access - ICICI Bank 1.4%||£71,420||£35,710|
|Top two-year fix - Paragon 2%||£50,000||£25,000|
|Top five-year fix - 2.8% from Shawbrook Bank||£35,715||£17,857|
A form of National Savings Certificate, premium bonds are effectively gilt-edged securities: you loan your money to the government and, in return, it pays you for the privilege with a guarantee it will return your capital at a specified date. Where premium bonds differ is that the interest payments (currently 1.5%) are pooled and paid out as prize money and you can get your cash back within a fortnight, with no risk. Launched by Chancellor of the Exchequer Harold Macmillan in his 1956 Budget, every single £1 unit has the same chance of winning and in May 2011, 1,772,482 winners (from a total draw of 42,539,589,993 eligible bond numbers) shared £53,174,500. The odds of winning are 24,000 to 1 and the maximum holding is £30,000 per person but it remains the only punt in which you can perpetually recycle your stake money.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Used by an employer or pension provider to calculate the amount of tax to deduct from pay or pension. A tax code is usually made up of several numbers followed by a letter. If you replace the letter in your tax code with ‘9’ you will get the total amount of income you can earn in a year before paying tax, for example 747L would mean a person could earn up to £7,479 before paying tax. The wrong tax code could mean a person ends up paying too much or too little tax.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.