Some may be forgiven for thinking savings are off-limits for the taxman. After all, savings have likely already been taxed as earnings. Unfortunately, this is not the case. This is because savings can become income in their own right.
This is known as savings income and it comes from savings interest. If it wasn't for tax on savings interest, people with enough money could merely place their money in a savings account. From there they could live off savings interest without having to pay tax.
For this reason, people pay tax on their savings interest. However, much like Income Tax brackets, there are certain savings interest thresholds people need to meet to pay tax. This article will look at these tax on savings thresholds, when to pay tax, and how.
A person's income from things like wages is also used in conjunction with savings interest to decide how much tax is owed.
As the name suggests, if your yearly income falls on or below a certain amount, you do not have to pay tax. This is known as the tax-free Personal Allowance. UK nationals have a tax-free allowance of £12,570.
This £12,570 Personal Allowance means that anyone earning this or less does not need to pay any Income Tax. So, how does this relate to savings income?
Does tax on savings interest start after meeting the Personal Allowance?
If your sole earnings come from savings income then you will have to pay tax on savings interest after the Personal Allowance has been met. This is set at the usual rate of income tax, as shown in the above table. However, if this is not your sole income stream further benefits are given.
For example, there is a further starting rate for tax on savings. This starting rate for savings is £5,000. This means you can add £5,000 of savings income to a maximum of £12,570 from other earnings to give a new threshold. This combined threshold is £17,570, meaning there is a tax-free allowance up until this level of income.
There is also the Personal Savings Allowance of £1,000. Basic rate taxpayers can add this allowance to the personal allowance, and the starting rate for savings. This gives a possible combined tax-free income of £18,570. If you are on the additional rate you are entitled to a £500 personal allowance also.
Joint account holders will have savings interest split equally between each person. If any savings interest amounts to £10,000 or more you will need to register for self-assessment.
A number of different types of savings are included. For example:
- Savings from bank and building society accounts
- Savings and credit union accounts
- Unit trusts, investment trusts, and open-ended investment companies
- Peer-to-peer lending
- Trust funds
- Payment protection insurance (PPI)
- Government or company bonds
- Life annuity payments
- Certain life insurance contracts
Are Individual Savings Accounts tax-free?
An Individual Savings Account, or ISA, is a type of savings account with different benefits from standard savings accounts. There are four different types of ISAs. These are:
- Cash ISA
- Stocks and shares ISA
- Innovative finance ISA
- Lifetime ISA
Every tax year (6 April to 5 April) you can put up to £20,000 into an ISA. You do not need to declare on a tax return any savings interest from an ISA. This is because there is no savings interest tax or Capital Gains Tax on ISAs. Any earnings can be kept, tax-free.
You do not have to put the full amount into just one type of ISA. You can spread your savings across some or all of the different types.
Can you lose money in an ISA?
Investing in an ISA is sometimes thought of as a risk-free investment that is free of tax. However, there is a small degree of risk. In cash ISAs the amount of money invested never drops. On paper, this means that there is only an upside as you cannot lose that money.
The risk comes when inflation is higher than interest rates. This means that over time, the value of the money you have invested is weakened. In terms of stocks and shares ISA the risks are multiplied. There is no guarantee that there will be any returns on investment. So, although unlikely you could potentially lose your investment.
In the event of a company collapse, the Financial Service Compensation Scheme will protect deposits of up to £85,000.
Do children pay savings interest tax?
Typically children do not pay tax on savings interest. However, if parents have placed money into the account which has earned more than £100 in interest, they will need to pay tax on it. This is if they have surpassed the Personal Savings Allowance.
This £100 savings interest limit does not apply to friends or relatives. This also does not apply to children's ISAs which have a limit of £9000. Up to £9,000 can be added to a child trust fund which they can take out when they reach 18. This type of trust fund is also tax free.
However, if the child has an income above the Income Tax Personal Allowance, they will still need to pay tax.
Do I pay tax on share-based investments?
Income from shares is known as dividend income. Dividends are the portion of profit you are given by the company you have invested shares in.
Investment funds that are placed in shares may also earn distributions in the same way as dividends. Dividend income and distributions are both taxed in the same way. The tax-free allowance for dividend income is £2000 a year.
Beyond this, basic rate taxpayers pay 8.75% on dividend income. Higher rate taxpayers pay 33.75% and additional rate taxpayers pay 39.35% on dividend income. Any dividend income received from a pension or ISA remains tax-free.
However, investing with authorised unit trusts and open-ended investment companies may grant further tax relief. Part of the returns you receive will count as taxable income, but some will count as capital gains. There is a capital gains allowance of £12,300, meaning up until that point capital gains are not considered taxable income.
Do I need to complete a Self Assessment tax return for savings income?
If any savings or investments earn interest amounting to £10,000 or more, you will need to report this to HMRC. If unreported HMRC will receive information from your bank at the end of the year, telling them how much interest you have earned.
This will still be required if you are unemployed, or do not receive a pension. HMRC will then let you know how much tax you are required to pay. Typically instead of paying the tax in one lump sum, they will change your tax code for the following year. This means you can spread out the payments over the year.
Can I reclaim tax paid incorrectly?
If you believe you have overpaid savings income tax then you may be entitled to a tax refund. If you are claiming an interest tax refund on savings an investment you will need to complete an R40. This can be completed online or by post.
In order to complete the online application, you need a Government Gateway password and user ID. This can be made using the online service. After completion, you will be issued a reference number that can be used to track the progress of the claim. There is a four-year limit on when you can claim, starting at the end of the tax year you are claiming for.
For people who now live abroad, they can use an R43 form.
One may be forgiven for thinking that when money is placed into a savings account it is safely stored away, free from scrutiny. However, that is not the case. This is because savings accrue interest over time which is known as savings income. So when paying tax, earnings from savings accounts must be accounted for.
However, if income comes solely from savings accounts you may be entitled to a tax exemption if it is less than a certain amount. Any interest earned must be less than the Income Tax Personal Allowance of £12,570 to be free of tax.
After that, basic rate taxpayers are charged 20% of their income (except Scotland at 19%). However, if you also have a job you may be entitled to further benefits when paying tax. This is because the starting rate for savings starts at £5000. This Personal Savings Allowance can be added to the Income Tax Personal Allowance to give a new threshold of £17,570. A further £1,000 of tax discount can be added by basic rate taxpayers using the Personal Savings Allowance.
Individual savings accounts further complicate the process by providing different tax allowances. A maximum of £20,000 can be placed in an ISA in a single tax year. Earnings from ISAs are tax-free and do not need to be declared on a tax return. There are four different types of ISA:
- Cash ISA
- Stocks and shares ISA
- Innovative finance ISA
- Lifetime ISA
Cash ISAs ensure funds do not drop below the original investment. However, the value of the cash deposit can drop if inflation is higher than interest rates. Stock and shares ISAs are riskier as you stand to lose the original investment if things go wrong. The financial service compensation scheme protects £85,000 of any deposit if a company goes bust.
Children usually do not need to pay tax on savings interest. However, if their parents have given them money, that has earned over £100 they need to pay tax on that. If a child's income is above the Income Tax Personal Allowance, this counts as taxable savings income.
The Dividend Allowance from shares ends at £2,000. Meaning any earnings from shares are not placed on the tax bill unless they are more than £2,000. Investing in unit trusts and open-ended investment companies on the other hand may reduce your total taxable income. This is because there is a Capital Gains Allowance of £12,300, which some earnings can come from.
If any interest earned or investment earnings amount to more than £10,000 you need to declare this to HMRC. HMRC will then inform you of how much tax is due. They typically create a new tax code for the following year, to spread payments rather than issuing a single lump sum.
If you believe you are due a refund on savings taxed then you can apply for this using an R40 form. This can be completed online using Government Gateway or sent in the post. There is a four-year limit by which time you can claim. Anyone applying from abroad can use an R43 form.