Since April 2016, your savings interest has been paid to you tax-free, and 95% of UK adults no longer pay tax on any saving – the biggest shake-up for a generation.
Previously, for every £100 interest earned, basic-rate taxpayers lost £20 in tax, higher rate £40. Yet now the new personal savings allowance (PSA) means every basic-rate taxpayer can earn £1,000 interest per year without paying tax on it (higher rate £500), equivalent to the interest on £74,000 in the top easy-access savings account. Here's the lowdown...
How much is the personal savings allowance?
It depends on what rate of tax you pay:
- Basic-rate (20%) taxpayers – will be able to earn £1,000 interest per year with no tax (so a max tax saving of £200 compared with before).
- Higher-rate (40%) taxpayers – will be able to earn £500 interest per year with no tax (so a max tax saving of £200 compared with before).
- Additional-rate (45%) taxpayers: £0 – they do not get an allowance.
The estimate is that it takes 95% of savers out of paying any tax on their savings. See the Treasury's factsheet for more information.
How much can I have in savings before I exceed it?
Here's a table of how much you'd need in a standard savings account to hit the thresholds (assuming current best-buy rates).
Is it just interest on savings accounts that counts?
In short, no. Any interest you earn from bank accounts, savings accounts, credit union accounts, building societies, corporate bonds, government bonds and gilts is covered. This includes interest earned on other currencies (eg, US dollars, euros) held in UK-based savings accounts.
Peer-to-peer lending interest is also covered, but dividend income from shares or funds is not included in the allowance. It also includes interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts and most types of purchased life annuity payments.
If I'm already saving into a tax-free account, is that interest covered by this allowance?
No. Interest that is already tax-free isn't included – so this includes ISA interest and Premium Bond 'winnings'. Interest from these will still be paid tax-free, it just won't count toward your PSA limit. So, if you get £500 in ISA interest, and you're a basic-rate taxpayer, you'll still have £1,000 of PSA to cover other interest.
Can my savings within the personal savings allowance push me into a higher income tax band?
Simply, yes. However, the tricky question comes if your non-savings income, which would generally be income from work (whether employed or self-employed), is below the higher-rate threshold but your savings income would take you above it.
So do you get the £1,000 for basic-rate taxpayers or do you get the £500 for higher-rate taxpayers?
To work this out you first must add up your income from work and income from earned savings interest to get your total income. If that total income puts you in the higher-rate band (starts at £45,000 in 2017/18 for England, Wales & NI - £43,000 for Scotland) then you are a higher-rate taxpayer and you only get the £500 of personal savings allowance (similarly for those at the additional-rate threshold – you wouldn't get the personal savings allowance at all).
Let's do an example...
The higher rate of tax starts on income above £45,000 (in the 2017/18 tax year for England, Wales & NI - £43,000 for Scotland). You earn £44,999 plus have £1,000 in savings interest. As your total income including interest is above the higher-rate threshold you'll only get the £500 personal savings allowance. So, £500 of your interest would be tax-free, while the remaining £500 would be taxed at the higher rate.
For a more detailed exploration of this, see Martin's blog on how the new personal savings allowance means some will be better off earning LESS interest.
How will I pay savings tax if I owe it?
HM Revenue & Customs has confirmed that any tax owing will be paid through changes to your tax code. So you'll get a lower personal allowance for income tax to pay any tax due on savings interest. Those who self-assess will continue to pay through that system (though a new digital system is replacing the annual tax return).
Your bank or building society will pay all savings interest due to you gross (without tax taken off the amount).
When will my tax code change?
HMRC has now finished sending out 2017/18 tax codes. Some will have seen their tax code is lower than the standard 1150L, as HMRC already expects they will earn more in savings interest than their personal savings allowance covers.
If this has happened to you, and you won't earn more than £1,000 in savings interest (£500 for higher-rate taxpayers), contact HMRC as they will need to adjust your 2017/18 tax code to be correct. You can call it on 0300 200 3300 or use its 2017/18 tax-code query form.
Is there no point in saving in an ISA then?
Even after all these huge changes, cash ISAs aren't finished...
Martin Lewis says...
For most people the personal savings allowance will mean all of their savings are tax-free, and therefore when choosing a product, the basic question is simply "What pays the highest rate?"
And for most people with under around £20,000 of total savings, cash ISAs won't be a winner. In fact all ISAs are easily beaten for most people by top easy-access savings, top bank account savings (where you get a high rate as part of your current account), and regular savings accounts.
It's rare, but occasionally the top easy-access cash ISA pays more than the top easy-access savings; in which case even if there's no tax gain, if the rate is higher, use the ISA. Plus the top fixed ISAs allow you to access your cash early for a small interest penalty while the top fixed savings don't – so there can be other reasons ISAs win; for nerdy detail on this, see my Is the cash ISA dead? point.
For bigger savers and higher earners a cash ISA is still a winner
The most important thing to note is that cash ISA interest doesn't count towards your PSA, so you can earn it tax-free – and still have your full £1,000 (or £500) PSA allowance. Therefore for top-rate taxpayers or bigger savers who've used up the PSA, there are big tax advantages of saving in a cash ISA.
- Basic-rate taxpayers over the PSA limit. For every £100 interest you earn in normal savings you only get £80, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 25% higher for it to beat a cash ISA.
- Higher-rate taxpayers over the PSA limit. For every £100 interest you earn in normal savings you only get £60, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 66% higher for it to beat a cash ISA.
- Top-rate taxpayers. For every £100 interest you earn in normal savings you only get £55, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 82% higher for it to beat a cash ISA.
So cash ISAs can be winners even with lower rates.
Also it's worth remembering that while £1,000 a year interest seems a lot now with our current pitiful interest rates, if interest rates rise then more people will need to pay tax. So saving into an ISA now could protect you from future tax.
For more on this read the full Why the cash ISA isn't dead point.
Is this allowance the same as my personal allowance?
This personal savings allowance is a radical departure for savings, creating it as a new tax bracket in its own right – within the income tax system.
You will get your savings personal allowance. It is completely separate from the personal allowance all taxpayers get on their standard income, where most can currently earn £11,500 before any tax is charged.
However, as we mention above, if you do owe tax on savings interest, your personal allowance will be lowered from £11,500 so you pay the right amount of tax.
To see your current take-home pay, use our income tax calculator.
Do the rules change if I'm a pensioner?
Quite simply the answer is no. The same rules apply.
What if I opened a fixed-rate bond before the PSA launched which matures soon?
We've been asked this a lot. The key about whether this is covered by the personal savings allowance or not is the ability to access the interest accruing on your account.
Almost all fixed-rate accounts don't let you touch either capital or interest during the term. So, if you took out a three-year fixed-rate bond in 2015, which only pays interest when it matures in, say, January 2018, then interest would be covered by the personal savings allowance as the interest only became accessible to you after the introduction of the PSA.
It's worth noting that the interest you receive when a fixed-rate bond matures could exceed your PSA for this year. HMRC's stance on this is that the tax is due when you receive the interest. Sadly you can't carry the PSA forward or backward into other tax years.
I'm a basic-rate taxpayer and my partner's higher rate. What personal savings allowance applies to our joint account?
In this scenario, the interest earned is assumed to be split down the middle.
You will get £1,000 of personal savings allowance, and your partner will get £500. So, if we assume interest earned on the joint account is £1,000, your remaining personal allowance will be £500 and your partner's will be used up. If they have other savings, they'll need to pay tax on any further interest.
Having said this, savings on joint bank accounts is more complicated and HMRC suggests in this instance contacting them to report the saving income of interest as appropriate.