If you earn less than £18,570 a year from earned income and savings combined, then all your interest from those savings is potentially tax-free. This is primarily due to what is called the ‘starting rate for savings’ which you get on top of your ‘personal savings allowance’. It can be complex, so read on:
If you earn interest on your savings, and your income from work or from your pension is rather modest, there are three allowances available that can mitigate the taxation of your savings’ interest.
Your personal allowance. This is the amount you can earn (currently £12,570 pa), whether from work, pensions or savings interest, that you do not have to pay income tax on.
A £5,000 starting rate for savings. If you’re on a lower income you may be eligible for an extra tax-free
allowance of up to £5,000 for your savings: If your income from pensions or work is under the personal allowance of £12,570, you get the full £5,000, meaning you can earn up to this amount in savings interest without being taxed. If your income from pensions or work is above the personal allowance of £12,570, you lose £1 of the £5,000 starting rate for savings for each £1 you earn above the personal allowance. If your income from pension or work is £17,570 or more. You don’t get any of the £5,000 starting rate for savings.
Your personal savings allowance. This is worth up to £1,000. The personal savings allowance (PSA) means everyone who just pays tax at the starting rate of 20%, can earn £1,000/year in savings interest before paying any tax on it. This is added on top of the £5,000 starting savings rate. So, if you’re on a low income, you’re able to earn up to £5,000 savings interest without paying tax but you’ll also pay no tax on the next £1,000 of savings interest – using up your personal savings allowance.
To summarise, many of you can have up to £18,570 tax free, because you only start paying tax when your income exceeds your £12, 570 personal allowance, In addition is the starting rate for savings (up to £5,000) and the personal savings allowance of £1,000, all in combination.
Some examples of how this works in practice…
A) Peter: Receives a £8,892 state pension and has £7,252 of savings income
In this scenario, Peter won’t pay any tax as his entire income from pensions is under his personal tax allowance of £12,570, so he’s not taxed on it. Of his savings, the first £3,678 of interest is also covered by his personal tax allowance. Then, the remaining £3,574 of interest is covered by the starting rate for savings, meaning Peter pays no tax.
B) Chris: Earns £15,080 from work, has £2,350 of savings income
Chris will pay £502 in tax, all of it on his income from work. This is because he earns £2,330 more than his personal tax allowance of £12,570. However, all his savings interest will be tax-free, as it’s covered by the starting savings rate. As Chris earns more than £12,570, his income from work starts to eat in to his £5,000 starting savings rate allowance. He loses £1 of starting savings allowance for every £1 he earns over his personal allowance, so he’s left with £2,670 (£5,000 – £2,330) of his starting savings allowance and this more than covers his £2,350 interest, so no tax is payable on it.
C) Bernie: No income from work, but has £19,000 of savings income
In this scenario, Bernie will need to pay tax of just £286. As he has no earned income, the savings interest is mostly covered by a combination of allowances:
Personal allowance – the first £12,570 is tax-free
Starting savings rate – the next £5,000 is tax-free, so £17,570 of the interest income is taxed at 0%
Personal savings allowance – means the next £1,000 is tax-free, so £18,570 is taxed at 0%.
This leaves Bernie with £430 of savings income which he will need to pay tax on. As he has no other income, this will be charged at the basic 20% rate, so he’ll pay £86 in tax.
D) Elly: Earns £33,500 from work, but has £5,000 of savings income
Elly will pay tax of £800 on her savings interest. The first £12,570 of her income from work is tax free, but she’ll pay basic-rate 20% tax on the amount above that. As she earns more than £17,570, there’s no starting rate for savings available to her. However, as a basic-rate taxpayer, she does get a personal savings allowance of £1,000, which covers some of her interest, but the remaining interest of £4,000 will be taxed at 20%, meaning she’ll pay £800 to HMRC, on top of the tax she pays on her salary.
How do I pay tax I owe on savings interest?
Your bank or building society will pay all savings interest due to you gross (without tax taken off the amount). It will then report the amount it’s paid you to HMRC each year. If you complete a SA tax return, you have to report any interest that’s eligible to be taxed on that form each year. HMRC will then work out if you owe it any tax.
If you don’t do Self-Assessment, any tax you owe on interest will be paid through changes to your tax code, with a lower personal allowance given to enable tax to be collected. HMRC automatically check on how much interest you received on savings interest in the previous year and adjust your tax code accordingly’
If you’ve had a tax code change in the past and are now earning less interest than your Personal savings allowance , you’ll need to contact HMRC as it will need to adjust your 2024/25 tax code to be correct. (Call on: 0300 200 3300) or you can do it online if you have an online tax account.
If you have paid too much tax you can reclaim it by filling in an R40 form and posting it to HMRC or, you can reclaim the tax via the self-assessment tax system if you normally complete a tax return.
My thanks to Money Saving Expert Martin Lewis and his team for providing much of the contents of this Blog on their website. If you want to read more, go to
https://www.moneysavingexpert.com/savings/tax-free-savings/
