If you've paid too much tax, could you be eligible for clawing some back?

You may have thought that Gordon Brown scrapped the 10p rate of income tax in April 2008. But sometimes interest on savings income is still liable to be taxed at 10%. The general rule is that savings income is taxed at 20% and that those who qualify for the 10% rate have to apply for a refund.

A Freedom of Information request by a group called Save Our Savers discovered that more than three million people should be paying only 10% tax on their savings interest, but very few of them realise they can claim back the overpaid tax.

What’s more, some people pay tax on savings interest when they should be entirely exempt. To give an example: Joe is 70, so he can have a tax-free income of £10,500 this year. His total income is just £8,500, so he should pay no tax on any of it. But the interest on his £10,000 savings is taxed automatically at 20%. His savings account pays 3% interest, ie £300 a year, but a fifth of that (£60) is automatically deducted, leaving him just £240.

To stop these deductions, Joe should fill in form R85 (obtainable from banks and building societies). When his building society receives the completed form, all future tax deductions will cease. Joe is also able to reclaim tax deducted over the previous four years.

You can use the table at the foot of this page to check your tax allowance for past years. If your income was less in any of those years, you should have paid no tax on your savings interest. The Revenue estimates that £200 million has been overpaid.

When tax is due

Unfortunately, things are not always quite so straightforward. Any income above your personal tax allowance is normally taxed at the basic rate of 20p in the pound. But if you have interest from savings, it is possible that some of it should still be taxed at only 10p in the pound. That is because on top of your personal tax allowance, there is a band of income that is taxed at 10% – but this applies only to interest on savings (including that on some National Savings products). When your tax bill is being calculated, your savings interest is always taken into account last (you can think of it as the cream floating on top of the milk). So all your other income – such as pensions and earnings – are the ‘milk’ and savings interest is the ‘cream’.

Inevitably, there are rules governing how much of the cream is taxed at 10% and how much at 20%. The bottom line in the table shows the maximum amount, on top of the personal tax-free allowance, that can be taxed at 10%. When totting up your total income, you must include state and private pensions, earned income, profit from self-employment and any rental income. You do not have to include income from the rent-a-room scheme (which is tax-free) nor dividend income.

If your other income above your personal allowance is as much as or more than the 10% savings band, all your savings interest is taxed at 20%. But if your other income on top of your personal allowance is less than the 10% band – and you have some savings interest – the amount of savings interest that sits within that band should be taxed at only 10%.

Examples

When trying to work out your tax liability, you need to know how much your gross pre-tax savings income was each year in question. You do that by multiplying the sum you actually received by five and then dividing the result by four. So if you got £1,000, the pre-tax amount would have been £1,250.

Take John, who was 70 in the tax year 2011/12. He had £11,000 from his state and works pension and he got £2,000 net interest on his savings. He grosses that up to £2,500 (£2,000 x 5 ÷ 4 = £2,500). In that year his personal tax-free allowance was £9,940. So the first £9,940 of his pensions was tax-free and the remaining £1,060 was taxed at 20%.

Only the savings above that level and within the savings tax band are taxed at 10%. In John’s case, £1,060 uses up some of the £2,560 savings tax band, leaving £1,500 of his savings income that should have beeen taxed at 10%. The other £1,000 of savings income on top of that is taxed at 20%. In fact, his building society had deducted 20% (£500) off all his savings interest, so he is due a refund of £150.

Another example: Jean is 63 in 2012/13, with an income of £10,500 from a state pension of £7,500 and interest of £3,000 from her savings. Her personal allowance this year is £8,105, so all her state pension and £605 of her savings interest is tax-free. The balance of her interest is £2,395. As this is less than the £2,710 savings tax band, it should be taxed at 10%, which amounts to £239.50.

Unless she has filled in and submitted form R85, her bank will deduct 20% from all her interest (£600) instead of £239.50, so she will be able to reclaim £361.50.

Put simply, if you have savings interest and your total income is less than your personal allowance plus the savings rate band in the table, you are almost certainly paying too much tax.

NB: my figures assume an income of below £42,475 this year. Those on a higher income pay tax at 40%.

Reclaiming overpaid tax

If you think you may have paid too much tax last year, or in any tax year dating back to 2008/09, you can try to claim it back now. You have to use a form called R40 (see below) – one for each tax year for which you are claiming a refund. Send them to your own tax office or to Leicester & Northants (Claims), Saxon House, 1 Causeway Lane, Leicester LE1 4AA.

Remember that married people are taxed separately and each spouse should work out their own figures. If money is in a joint account, interest should be apportioned equally between the two.
 
More information

Forms R85 and R40 can both be obtained from your local tax office or by calling a special HMRC helpline (0151 472 6080). Or visit hmrc.gov.uk and put R85 or R40 in the search box and download them.

Advice is also available from the campaigning group Save Our Savers - see @SaveOurSavers on Twitter.