Tax-free savings & the starting savings rate
If you're a low earner, then since April 2015 you've been able to register to earn savings interest without paying any tax on it. This is different to the personal savings allowance – though it complements it – but how this starting savings rate works in practice, and who qualifies, is a bit more complex...
What's tax-free savings and the starting savings rate? Simply put, for most people these mean that if you earn less than £18,500 a year in income and savings interest combined, you won't have to pay any tax on the interest paid on the savings.
Hold on, I thought I wouldn't pay savings tax under this personal savings allowance anyway? Not quite. Your personal savings allowance means every basic-rate taxpayer is able to earn £1,000/year in savings interest before paying any tax on it (and higher-rate taxpayers can earn £500).
The personal savings allowance adds to these tax-free savings rules. You're still able to earn £5,000 savings interest without paying tax, if you're on a low income, but you'll also pay no tax on the next £1,000 of savings interest – as you use up your personal savings allowance (assuming you pay no or basic-rate tax).
Okay, why's the limit £18,500 – sounds like a random figure? Well, it's made up of three separate allowances. The first is your personal allowance – this is the amount you can earn without paying any income tax – for most people this allowance is £12,500 (for 2019/20).
On top of that allowance there's the £5,000 starting savings rate where the tax rate is 0%, so again this is the amount you can earn in savings interest before paying any tax on that.
Finally there's the personal savings allowance worth up to £1,000.
What happens if I earn between £12,500 and £18,500? This is where it gets a little complicated. For every pound you earn (ie, not from savings) above £12,500 you lose a pound of savings allowance. An example will help...
If you earn £13,500 you're £1,000 above the standard personal income tax allowance, so the £6,000 savings allowance (the starting savings allowance plus the personal savings allowance) is reduced by that sum, giving you £5,000 more you can earn in savings and it still be tax-free.
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So does this mean I won't pay any tax if my total income's below £18,500? Sadly not. The personal income tax allowance still stands. So, for example, if you earn £14,000 a year, you'll still have to pay income tax on £1,500 of that (the amount above your personal allowance), which'd mean you pay around £300 in tax. Plus, you still pay national insurance on earnings above £8,632.
However, if you also had savings and earned £80 in interest from that, it would mean you wouldn't pay any tax on the interest – you'd get to keep the full £80.
I think I get it. But what if I earn less than the threshold but my savings interest takes me over it? Well, you should still be able to get some savings tax-free, but this does get a bit more complex. All savings interest is now paid tax-free, but if you'll earn enough interest to push you over the threshold you'll need to pay some tax. This is done through your tax code if you're employed, or through self-assessment if you use it.
You would still be guaranteed to get the personal savings allowance of £1,000.
So, for example, if you earned £17,000 in income, and had £1,600 in savings interest, your total income's over £18,500, so you would pay basic-rate tax on the final £100 of savings interest.
If you've paid too much tax on savings interest in previous years, you can reclaim it. Either fill in an R40 form to send to HM Revenue & Customs, or you can reclaim through the self-assessment tax system if you fill that in anyway.
Does the £18,500 limit apply to everyone? No, if you have a higher personal allowance for income tax, your limit rises by the same amount. So...
- If you get the blind person's allowance, your limit would be £20,950.
- If you get the married couple's allowance, your limit will be raised, though by how much depends on your circumstances. Use the Married Couple's Allowance calculator to find out, then add £18,500 to find your limit.
You can find your likely personal allowance at Gov.uk.
To sum up, to find your limit for tax-free savings, find out your personal allowance and add £6,000 to it.
So what happens next? Do you have to register with your bank or building society to get the personal savings allowance? No, all banks and building societies will pay all interest to you with no tax taken off. If you then owe tax, you'll pay it through your tax code (it's likely your personal allowance will be lowered).
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