For many years banks have deducted tax from interest they paid to savers, unless the particular ac- count was designated as tax-free, such as an ISA. That default position has changed from 6 April 2016.
Now all bank and building society interest is paid without tax deducted, but the individual saver is taxed on the interest they receive. However, most taxpayers are eligible to be taxed at 0% on all their savings income, which includes interest, so no tax is payable.
This zero tax rate applies if the savings income falls within the taxpayer’s savings rate band (worth up to £5,000 per year) or within their savings allowance (worth up to £1,000 per year). Any savings income which falls outside that rate band or allowance is taxed at the taxpayer’s marginal income tax rate (20%, 40% or 45%).
Dividends are not categorised as savings income as they are subject to different tax rates and allowances. How much savings rate band (SRB) you have available depends on the level of your taxable non-savings income for the year. Any salary, pensions, trading profits or rent you receive, which exceeds your personal allowance, eats up your SRB.
Example
Colin receives a pension of £16,000. After deducting his personal allowance of £11,000, he has £5,000 of taxable pen- sion. This entirely eats up his SRB, so he has no SRB band to set against his £1,500 of saving income.
Colin’s total taxable income is £6,500 (£5,000 pension + £1,500 interest), which falls within the basic rate band (up to £32,000). As a basic rate taxpayer, Colin is entitled to a savings allowance of £1,000. He deducts this allowance from his savings income of £1,500, leaving £500 taxable at 20%. Colin pays tax of £100 (£500 x 20%) on his savings income.
Marginal taxpayers
Higher rate taxpayers are entitled to a savings allowance of £500 and additional rate tax- payers (income over £150,000) are not entitled to the savings allowance.
Taxpayers whose income pushes just over the basic rate band into 40% tax rate, will lose half of their saving allowance. Straying over the £150,000 threshold, will mean all the savings allowance disappears.
The boundaries between the tax rates can be expanded by making gift aid donations or personal pension contributions. We can calculate whether an additional pension contribution or donation will reduce your total tax bill.
