Savers face paying tax on their interest for the first time in seven years, as rising rates and savings levels mean they risk busting the personal savings allowance.
Introduced in 2016, it allows basic-rate taxpayers to earn £1,000 savings interest a year tax-free. Higher-rate taxpayers get a £500 allowance. Additional rate payers receive nothing.
Working out what you owe is complicated. There are three allowances: the personal allowance (£12,570 this tax year), the £5,000 ‘starting savings rate’ and the personal savings allowance.
A combination of rising interest rates and bigger savings pots means savers are now at risk of busting the personal savings allowance
You first need to separate the interest from savings and non-savings income.
Say you earn £16,000 from a job or pension and £4,000 in savings income. Set the personal allowance against your income.
You pay nothing on the first £12,570 and 20 per cent on the remaining non-savings income of £3,430 (£16,000 – £12,570). This equals a £686 tax bill.
Next is the £5,000 starting savings rate allowance, available to those on low incomes.
This varies. For every £1 of non-savings income over your personal allowance, the rate is reduced by £1.
Deduct the £3,430 earned over the personal allowance from the £5,000 limit. This would cut your starter rate allowance to £1,570, on which you pay 0 per cent tax.
You then deduct this from the £4,000 interest earned on your savings. At this point you have £2,430 (£4,000 – £1,570) of potentially taxable savings income.
Finally, apply your £1,000 personal savings allowance. This reduces the taxable amount further to £1,430.
As a basic-rate taxpayer you will pay 20 per cent tax on this — £286. So your total tax bill for the year is £972 (£686 on a pension or salary, plus £286 on savings income).
There is a complication with fixed-rate bonds which run for more than a year.
Over a three-year term, for example, you may only qualify for one personal savings allowance if you cannot access your cash during the term.
Interest earned on cash Isa savings is tax-free.
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