Title
The taxman is coming for your savings – how to stop him
Authored on
09 Jun 2023 Two factors are at play here: one positive and one negative. First up, the good news: we’re getting more interest on our savings. Since the Bank of England put up interest rates savings rates have been rising, and they’re now pretty decent. This means that for every £1 you have in your savings account you’ll be getting a bit more return on it (assuming you’ve switched to get a better rate – if not, do that immediately).
The bad news is that because the Government hasn’t changed the point at which we hit the difference income tax thresholds, we’ll get less of that savings income tax free. Here’s how it works: most people have an amount of interest they can earn on their savings before they have to pay tax on it – called the Personal Savings Allowance. For basic-rate taxpayers that’s £1,000, for higher-rate taxpayer it’s £500 and then additional rate taxpayers don’t get any allowance. After that you pay your income tax rate on your savings. So a basic-rate taxpayer would pay 20% on any interest over their £1,000 allowance, a higher-rate taxpayer would pay 40% interest on any savings interest over £500 and an additional-rate taxpayer pays 45% interest on all their savings interest.
But someone who is on the cusp of the next income tax band and who gets a payrise could tip over into the next tax bracket. This hits them with a double whammy – they lose some or all of their tax-free savings allowance and they are now in the next income tax band and so have to pay a higher rate of tax on their savings.
Let's take the example of Lucy
She was earning £48,000 and so was a basic-rate taxpayer and got £1,000 Personal Savings Allowance.
If she got £1,200 in savings interest she’d only have to pay tax on £200 of that (the rest is covered by her allowance) and she would pay 20% tax on it, so that’s £40 in tax.
However, she’s doing awesomely in her job and gets a pay rise to £52,000 (go Lucy!). That now makes her a higher-rate taxpayer, so paying tax at 40%, and means that her Personal Savings Allowance is just £500.
If she gets that same £1,200 of savings interest she’ll now pay tax on £700 of it and she’ll pay 40% tax on that money, leaving her with a much higher tax bill of £280.
On top of this, the Government reduced the threshold where people become additional rate, or 45%, taxpayers in April this year. It means that now anyone who earns more than £125,140 will be an additional rate taxpayer and so get no tax-free savings allowance (previously the threshold was £150,000). They will also pay 45% tax on their savings interest, rather than 40%. So someone who earned £140,000 and got £500 in savings interest last year would pay no tax on it, as they would have been a higher-rate taxpayer and covered by the £500 Personal Savings Allowance. But this year if they got that same £500 in savings interest they would be taxed on the whole lot at 45%, meaning a £225 tax bill.
How can I beat the taxman?
We’re here to present the solutions not just the problems – and fear not, there are many solutions.
Use an ISA
Any money inside a cash ISA won’t count towards your Personal Savings Allowance and so is tax free. Everyone gets a £20,000 annual ISA allowance, so you can put a lot of money aside each year and protect it from the taxman’s clutches (just double check you haven’t made other contributions to other ISAs this tax year, as this limit is for all ISAs).
Use your pension
Pensions have a great ability to save you tax. Not only do you get all the great benefits of tax-relief on your pension contributions but they are great at taking you back to a lower tax band – magical. If you’ve just tipped over into the next tax bracket, if you make a pension contribution it can bring you back under the threshold. This means you’ll get a bigger Personal Savings Allowance and pay a lower rate of tax on your savings. It’s a bit confusing, so let’s look at it in practice: some who has income of £51,000 is just over the higher-rate tax threshold of £50,271. But if they make a £1,000 pension contribution it will take them back under it into the basic-rate threshold, meaning they get a higher personal savings allowance and only pay 20% tax on savings income over that, rather than 40%.
Move money to your spouse (or vice versa)
If you’re married or in a civil partnership and one of you earns less than the other, it can make sense to move savings to the lower taxpayer – or put it in a joint account. The big caveat here is that you need to be comfortable having shared money or handing money to your spouse – this isn’t an option for those wary of sharing money. But by shifting some savings to the partner in the lower tax bracket you can make sure you’re maxing out both your Personal Savings Allowances and any excess savings interest is taxed at the lower rate. What’s more, if you earn less than £17,570 you could benefit from a more generous tax-free allowance on your savings income of up to £5,000. Check out more information on MoneyHelper.
We don’t offer advice, so it’s important you understand the risks, if you’re unsure please consult a suitably qualified financial adviser. The value of your investments can go down as well as up and you may get back less than you originally invested. How you're taxed will depend on your circumstances, and tax rules can change. Tax, ISA and pension and rules apply.
These articles are for information purposes only and are not a personal recommendation.
