How Personal Savings Allowance Works

There are different types of accounts that banks and building societies in the UK offer. Of them, the Savings account is quite popular as it allows people to grow their money by doing nothing. In other words, savings accounts do the work for you. Unlike a current account that you use for day-to-day deposits and withdrawals, a savings account stores your money for future use. Also, banks and building societies pay little or no interest on current accounts but a comparatively high interest rate on savings accounts. That’s the reason savings accounts are the much preferred. They grow your money quicker.

 

Savings Accounts- In Brief

Saving is a good habit as it ensures you have money on hand if you are caught in an emergency. Small and regular savings every month can give you high returns in the long run. Savings accounts work such that you deposit some money into the account every month. Banks pay you a certain rate of interest on the amount lying in your account. You may choose to receive this amount in lump sum annually or in part monthly. So, the more you save, the faster your savings grow. You can use this money in any way you want. You can go on a holiday abroad or even pay it as a one-time deposit on a house or car. Savings accounts are of various types- cash Isas, easy-access, notice, regular and fixed-rate bonds.

 

Personal Savings Allowance- Meaning

A special type of savings account Cash Isas does not tax the interest you earn on savings. That means, the interest is tax-free as long as it’s a Cash Isas bank account. However, even with non-Isa savings accounts and current accounts, you can save on your tax with the help of personal savings allowance. The UK Government introduced this in April 2016 and savers have been overjoyed ever since. Let’s first understand the UK tax slabs for 2018-19 to get more clarity on this.

PAYE Tax Rates & Thresholds	2018-2019
Employee Personal Allowance	£228/week £988/month £11,850/year
Basic Tax Rate	20% on earnings between £11,851 and £46,350
Higher Tax Rate	40% on earnings between £46,351 and £150,000
Additional Tax Rate	45% on earnings above £150,000

 

The personal savings allowance makes a basic-rate taxpayer (20%) eligible for £1,000 of tax-free interest and a higher-rate taxpayer (40%) eligible for £500 of tax-free interest. This benefit does not extend to additional-rate taxpayers. Those having an annual income of £150,000 or above have to pay tax on all their savings.

Personal Savings Allowance- How It Works

A personal savings allowance helps you reduce your tax payments if your savings account is of any other type than a Cash Isa (Individual Savings Account). Let’s look at a few examples to understand how this savings allowance works.

For Basic- Rate Taxpayers:

You earn £25,000 a year and £500 as savings interest- you won’t have to pay any tax as exemption for basic rate taxpayers is upto £1,000.

You earn £25,000 a year and £1,500 as savings interest- tax is free on the first £1,000, but you have to pay basic rate tax 20% on the remaining £500.

For Higher- Rate Taxpayers:

You earn £80,000 a year and £400 as savings interest- it’s tax-free as it’s less than your personal savings allowance of £500.

You earn £80,000 a year and £1,500 as savings interest- tax is free on the first £500, but you have to pay higher rate tax 40% on the remaining  £1,000.

 

Use of Personal Savings Allowance

You can’t take the benefit of personal savings allowance if your savings account type is Cash Isas and some NS&I savings products (like premium bonds) as they’re already tax-free. This allowance is applicable to all other types of bank accounts- non Isa savings accounts and current accounts. You can also take advantage of the personal savings allowance against interest earned from:

• Corporate or government bonds
• Peer-to-peer loans
• Income from bond funds, authorized unit trusts, open-ended investment companies and trusts

Whether your income from investments is taxed as savings or dividends depends on the nature of the investments. Any income you earn from loan-based investments is considered as interest. Profits from company shares are considered as dividend income. As for profit from leased property, you have to pay tax on it as work or pension income.

 

Interest Exceeding Personal Savings Allowance- What Happens Next

If your savings interest exceeds your personal savings allowance (£1,000 for 20% taxpayers and £500 for 40% taxpayers), tax is automatically deducted by the PAYE (Pay-As-You-Earn) system with the details provided by your bank or building society. You can also declare it on a self-assessment tax return if you usually complete one. There are plans to revolutionise the working of the current tax system, by which individual digital tax accounts would process your interest.

 

Paid Too Much Tax on Interest- What You Can Do

If your bank or building society has wrongly calculated tax on interest without considering your personal savings allowance, you can reclaim excess tax paid. You just need to fill in the R40 form. You can claim wrongly charged tax upto four previous tax years. Normally, it’ll take upto six weeks to get your money back.

 

Low Income Earners- Extra Tax Break

The Government is providing an extra tax break for people who earn a very low annual income. This is in addition to their personal savings allowance. Because of extra tax breaks, low earners have to pay no or low tax on their savings. Let’s understand three terms here.

Personal Income Tax Allowance:

Every individual has a personal income tax allowance of £11,850 (2018-19) which is tax-free. If their income is below this threshold, they pay no tax.

Starting Rate for Savings:

This is a tax break for those individuals whose income is very low and falls within certain limits. This gives the benefit of 0% tax rate upto an amount of £5,000.

Personal Savings Allowance:

Personal savings allowance is £1,000 for taxpayers in the basic tax bracket and £500 for taxpayers in the higher tax bracket.

 

Example:

If you earn £15,000 annually and £4,500 savings interest, your tax will be calculated in the following manner:

0% on the first £11,850 = £0

20% tax on the remaining £3,150 (£15,000 – £11,850) = £630

0% tax on £1,850 (£5,000 starting rate for savings – £3,150) = £0

0% tax on £1,000 using the personal savings allowance = £0

20% tax on remaining £1,650 savings interest = £330

 

Total tax: £960

 

Isas Are Not Pointless

The interest on non-Isa savings accounts is usually much higher and low income earners have generous tax breaks as well. So are Isas pointless? Not really. If you’re a high income earner or possess huge savings, Isas are beneficial in the long run. The best way to make the most of your savings is to boost returns and minimize tax payment by combining a range of financial products. Personal savings allowance may not be there next year or the year after, but Isas will remain tax-free for a long time to come.

 

Read more:
Bank accounts in the UK