At the moment any interest paid on cash savings has basic-rate tax deducted from it. The bank or building society automatically takes off 20% tax and sends the money direct to the Treasury.
So if your savings earn £10, you get £8 and the Treasury gets £2. People who pay no tax can reclaim the tax from HMRC. People who pay higher-rate 40% tax must pay another 20% at the end of the tax year through self-assessment or PAYE.
How safe are your savings?
That complex system ends next month. From April 6, all interest will be paid gross with no tax deducted. That is good news for non-taxpayers – many of them never claim back the tax wrongly deducted from their interest.
How will the new system work?
People who do pay income tax will have to pay any tax due. But very few will actually have to do so because there will be a new personal savings allowance. The first £1,000 of interest earned will be tax-free for basic-rate taxpayers. At current interest rates of, say, 2% on a one-year bond that means you can have up to around £50,000 in savings and pay no tax on it. That will save £200 a year.
Higher-rate taxpayers with an income over £43,000 will get a smaller tax-free personal savings allowance of £500. They will have to pay the full 40% higher-rate tax on the excess so the £500 allowance will also be worth £200 a year for them.
Those who have an income over £150,000 paying the higher 45% additional rate of income tax will not be entitled to the new personal savings allowance.
How to boost your savings returns.
Bonds: timing is everything
The new rule begins on April 6, 2016. It applies to any interest on savings that arises from that date.
So a fixed-term bond where the interest payment is due on April 5 will come under the old system and be paid with basic-rate tax deducted.
But if the interest payment is due on April 6 or later, it will come under the new system and be paid gross. The National Savings and Investments 65+ Guaranteed Growth Bonds will be subject to these rules.
So, if you bought the one-year bond on April 6, 2015 or later, the one-year interest will be paid gross. On the three-year bond the first payment will be paid net or gross depending on when you bought it. However, the second and third year of interest will be paid gross.
Read Annie Shaw's guide to spring cleaning your savings and ISAs.
Claim back tax – fast!
If you are a non-taxpayer but have not had your interest paid gross in the past, you can reclaim the amount overpaid back to 2011-12 if you apply by April 5.
If you wait until after that you will be able to claim tax back only to 2012-13. Use form R40 – one for each tax year.
There is around £200 million waiting to be reclaimed. So get yours before time runs out!
Could you be sitting on a fortune?
Get £5,000 tax-free
The £1,000 personal savings allowance is in addition to the 0% band for interest that applies to those on lower incomes. If your income from a pension or earnings or other sources is below £16,000, then you can benefit from this 0% band.
Think of savings interest as the cream on top of your income – it floats. So the pension, earnings or rental is the bottom layer and uses up your personal tax allowance of £11,000 for 2016-17 first. Any savings interest floats on top of that.
The first £5,000 of savings interest above your personal tax allowance has a special 0% rate of tax. If your other income is £11,000 and uses up all your personal allowance, no tax is due on that. You can then have another £5,000 of interest and pay 0% tax.
Got a pensioner bond? What are your options when it matures?
If your other income is £14,000, there is still £2,000 of this band left. On top there is the £1,000 personal savings allowance that is tax free. So you can have up to £17,000 income and pay no tax if your income from pension, earnings and rent is £11,000 or less. Hopefully this rather complex system will be simplified soon!
In theory, someone with no other income could have more than £1.5 million saved in a National Savings and Investments Direct Saver and pay no tax on the £17,000 annual interest it would earn.
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Check your cash ISAs
The Government says that from April, 95% of savers will not earn enough interest to pay any tax. For them, is there any point in putting money into a cash ISA?
At the moment ISAs pay lower rates of interest than regular savings accounts. So there is no point in worrying about a cash ISA unless you will earn enough interest in a regular savings account to pay tax on it.
As a rule of thumb, that means you have more than £50,000 savings as a basic-rate taxpayer or more than £25,000 for a higher-rate taxpayer. But if you also benefit from the £5,000 0% band it could be a lot more.
For more information, visit gov.uk and search for ‘personal savings allowance’ and ‘tax-free savings interest’.
Should you invest in a stocks and shares ISA?
The way dividends on shares are taxed is also changing radically from April. At the moment dividends are paid with basic-rate tax accounted for. So basic-rate taxpayers do not have to pay tax on the dividend. Higher-rate taxpayers pay tax that is in effect 25% of the dividend.
From April everyone will get a tax-free dividend allowance of £5,000 a year.
If your dividends amount to more than that – which probably means you have £150,000 of shares or thereabouts – then you will pay more tax as a basic-rate taxpayer.
Above that, dividends will be taxed at 7.5% for basic-rate taxpayers and 32.5% for higher-rate taxpayers. That will mean more tax for those with substantial shareholdings – perhaps worth £650,000 or more. But for everyone else it will mean no change or lower tax. The new tax will not apply to dividends on shares held in an ISA.
For more tips and useful information, browse our money articles.
Changes in dividends from April 2018
There was a big cut this year, 2018, in the amount of dividend income that is free of tax. A £5,000 dividend allowance, which only began for the year 2016/17, was slashed in 2018/19 to £2,000. Shares worth £50,000 or less can produce dividends of this size, and income tax must be paid on the excess. Basic rate is 7.5%, higher rate 32.5% and top rate 38.1%.
For more information on dividend allowances click here.
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