If you are starting to save, then it’s worth thinking about how the UK government taxes your savings.
Fortunately, in April 2015, the UK government introduced tax-efficient savings regulations designed to help low-income savers. These involve stipulated limits depending on your income and other benefits. If you earn interest above these limits, your savings will be taxed.
You can earn interest tax-free on savings using several different allowances with limits as shown below. Please note that all the amounts refer to the tax year 2020/21.
This is an allowance available to most people resident in the UK. The basic personal allowance is £12,500 over the financial year. You can earn money up to this amount tax-free.
If you have not already used this allowance with your wages, pension or any other taxable income, then you can use it to earn interest on your savings tax free.
Starting rate for savings
This is for savers using their personal allowance with wages, pensions or other taxable income.
It’s an amount you can earn in interest without having to pay tax in the year. The amount depends on your income, but the maximum is £5,000. People with lower incomes will pay less tax on savings.
Someone that earns £12,500 per year will be able to earn the maximum start rate for savings of £5,000. Someone earning more than £12,500 will be entitled to a lower amount for their start rate for savings. The start rate for savings will be reduced by the amount earned above the personal allowance.
So, for example, someone earning £12,500 and receiving £500 savings interest in the year will have a start rate for savings of £5,000. They will not have to pay tax on savings interest of £500.
However, someone earning £17,000 and receiving £500 savings interest will have a lower start rate for savings. It will be reduced by £4,500, the amount earned above the personal allowance (£17,000 – £12,500). This means the start rate for savings is now £500, so they would not have to pay tax on savings.
The upper income limit is £17,500. So someone earning this amount will have a start rate for savings of £0. However, if you are claiming Blind Person’s Allowance, the upper limit will be £19,950. So the amount you can earn in interest without having to pay tax will be £7,450.
Similarly, if you are claiming Married Couple’s Allowance, your upper income will also be higher, but the amount will depend on your personal circumstances. If you are in this situation, consult HMRC for more information.
Personal savings allowance
You may also be eligible for the personal savings allowance depending on your income tax band.
If you are a basic rate taxpayer, you can earn up to £1,000 interest tax-free on savings. Higher rate taxpayers can earn up to £500. Additional rate taxpayers will not be able to earn any interest tax-free on savings.
Tax on savings
If you earn interest on savings above the allowable amounts, you will have to pay tax on your savings interest. The rate of tax you pay will be at your usual rate of income tax when accounting for your total annual income.
Check the HMRC website if you are uncertain about your tax rate. It gives separate information on the income tax rates and personal allowances for residents in England and Wales, and those in Scotland.
Tax on dividends
You will not pay tax on dividends earned within your personal allowance. If you have used up your personal allowance on other sources of income, you will be able to earn up to £2,000 in dividends tax-free.
Any dividends earned above the £2,000 allowance will be subjected to tax. The tax on dividends is based on your tax band. Basic rate taxpayers pay 7.5% tax on savings above the allowance. Higher rate taxpayers pay 32.5% and additional rate taxpayers pay 38.1%.
If you have earned dividends above your allowance and have to pay tax, you can do this by filling in a self-assessment tax return. If you are still working, you could also request that HMRC changes your tax code so that the tax on your savings will be taken directly from your wages.
All UK residents aged 16 or over can open an Individual Savings Account (ISA). You do not pay any tax on interest, dividends or capital gained within an ISA. You can deposit up to £20,000 in an ISA in the financial year.
The savings allowances apply to interest from a selection of different financial institutions. The list of institutions can be found on the HMRC website.
Make sure you are getting the best deal on your savings. Check out the best savings accounts of 2020.
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