🔔 Are you paying too much tax on your savings?

With interest rates plummeting over the last year, some savers may have paid tax on interest that they have not received.

Back in 2015 the then Chancellor of the Exchequer, George Osbourne, introduced a new allowance for savers – the Personal Savings Allowance (PSA) – which was introduced from April 2016. This allowance means that basic rate taxpayers pay no tax on the first £1,000 of the total savings interest from all of their cash savings (excluding any tax-free interest earned on cash ISAs).

For higher rate taxpayers, the allowance drops to £500 - additional rate taxpayers don’t receive a PSA at all.

At the time the allowance was introduced, the Government estimated that it would mean that 95% of savers would no longer pay tax on their savings.

And with rates tumbling, more people will probably be earning less than their PSA. For example, with the best easy access accounts paying 0.50%, a basic rate taxpayer would need to have more than £200,000 deposited before breaching the allowance.  

As a result of the introduction of the PSA, the way in which savings interest is taxed was amended.

Before the PSA was introduced, savings interest was paid out after the deduction of basic rate tax (20%) as, unless you were a non-taxpayer, by deducting it at source, it made it easier for the majority.

Non taxpayers were able to declare their status by completing a form which would then allow them to receive their interest tax free. Higher and additional rate taxpayers needed to pay the difference between the 20% deducted and their marginal rate of tax.

Due to the introduction of the PSA, as it was estimated that the majority will no longer pay tax on their savings, with effect from 6th April 2016 the deduction of tax at source was scrapped and now all savings interest is paid out gross.

While this is good news for those whose interest earned remains within the PSA, for those who do exceed it, it can cause some complexity and it puts more of the onus on those savers affected to check that they are paying the right amount of tax.

Those who receive income subject to the PAYE scheme - so those who are employed or retired and receiving an occupational pension, for example - will see an amendment to their tax code, which will be calculated based on the amount of interest HMRC anticipates they will earn. But they will be looking back at past interest earned and cash balances held.

Those with a 12 month bond maturing now could have been earning as much as 1.66% gross – which means that for a basic rate taxpayer, a deposit of more than £60,241 would see them breach the allowance. But if they are reinvesting today, with the best 1-year bond currently paying 0.65% AER, that £60,241 would earn just £392 – well below the PSA.

So, if the amount of interest you are expecting to earn in the current tax year is different to that of last year, you may end up either paying too much tax or having a liability.

Interest rates have plummeted in 2020 which is likely to make a difference to savers, in particular those with large amounts  held in cash. And with such low interest rates, many may decide that cash is no longer the best place for their money – and therefore the amount they hold in cash and earning interest, will fall.

All these things could lead to a tax code that does not reflect your circumstances and therefore you could be paying too much tax.  So, check your tax code carefully (many of these will be sent out in February and March to cover the new tax year, which starts on 6th April) and check that the interest that HMRC has assumed you will earn, is similar to what you expect to earn. If it is way off, you can try calling HMRC on 0300 200 3300 to update them.

If you’re dismayed with the rates being offered by the banks and would like to explore other options outside of cash why not get in touch. We’re currently offering all those with £100,000 or more in savings, investments or pensions a FREE financial planning review with one of our TPO colleagues, worth up to £500. You can find out more here.