There are some big changes happening to personal finances in 2016, but the introduction of a Personal Savings Allowance may be the biggest of all.
Under the new allowance, basic rate taxpayers will be able to earn £1,000 interest on their savings, tax free. Higher rate tax payers will receive a £500 allowance although additional rate (45%) taxpayers will not receive any allowance at all.
The scheme should see 95%of savers no longer paying any tax on their savings income.
But what does this actually mean?
Saving looks more rewarding
Currently basic-rate taxpayers give the taxman £20 for every £100 interest they earned, while higher rate taxpayer hand over £40. The new personal savings allowance means every basic-rate taxpayer can earn £1,000 interest without paying tax on it.
So saving looks much more worthwhile – with interest rates so low, you would need around £75,000 in the top easy-access savings account before you started paying tax at the basic rate.
It’s not just bank savings accounts that look more rewarding. Credit union accounts, building societies, corporate bonds, government bonds and gilts are all covered. This includes interest earned on other currencies (such as, US dollars or euros) held in UK-based savings accounts.
Interest from peer-to-peer lending and unit trusts, open-ended investment companies, investment trusts and most types of purchased life annuity payments are also covered, but dividend income from shares or funds is not.
How will it work?
When the new allowance starts in April, tax will stop automatically being deducted by banks as the vast majority of customers will have none to pay, meaning payments will be made gross.
Instead. HM Revenue & Customs has confirmed that any tax owing will be paid through changes to your tax code based on information provided to HMRC by account providers. . So you'll get a lower personal allowance for income tax if you do have to pay any tax due on savings interest. If you self-assess you will continue to pay as you do now.
One thing to be careful of – your extra income thanks to your personal savings allowance will be added to your overall income for tax purposes, It could push you into a higher income tax band.
What about ISAs?
Interest that is already tax-free isn't included – so ISA Interest will still be paid tax-free, and 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 interest from other savings.
It might be tempting to think that there is no further need for Cash ISA investments. Many savers found low interest rates meant cash ISAs had little to offer even before the budget. With adjustment for inflation, savers who used their full cash ISA allowance each year for the past 15 years have actually seen the value of their money fall in real terms.
It looks as though the Chancellor’s changes are simply the final stage of a decline that began when the Bank of England dropped rate to 0.5%, and banks and building societies followed suit.
But before you withdraw all the cash built up in your ISA, remember, your ISA protects your savings from interest permanently.
If you’re a higher rate payer putting £15,000 a year into an ordinary savings account paying 1%, it would take you around three years to reach the point (£50,000) where you will earn £1000 in annual interest. But after that, you will find yourself paying tax on your interest again.
If you had put the money in an ISA offering the same rate, all your returns would be tax free.
How to pay less tax.
The personal tax Allowance is good news, and should help you pay less tax. But for a better answer to the question ‘how can I reduce my tax bill?” you need proper financial planning for all your savings, pensions and other arrangements As with all financial decisions, it makes sense to get professional advice. To discuss the advantages and disadvantages of different savings products, taxation or financial planning generally, contact us today.
A quick guide to Personal savings allowance
- From April 2016, most people will have a personal tax free allowance for interest on savings
- For lower rate tax payers this will be £1,000
- Higher rate tax payers will only receive a £500 allowance
- Anyone earning more than £150k a year will not receive a personal allowance
- Beyond the allowances, lower rate taxpayers will pay 20% on savings income, and higher rate taxpayers 40%
- Savings plans such as ISAs which are already tax-free are not affected
The Financial Conduct Authority does not regulate taxation and trust advice.
Levels and basis of reliefs from taxation are subject to change