Tax on savings and investments – why it matters

Most savers can grow their money free of tax, thanks to the ‘personal savings allowance’. This guide will help you get to grips with how tax on savings interest is calculated, how the personal savings allowance works and whether your investments could be subject to tax.

Tax on savings accounts

Interest from savings is now usually paid gross, which means tax is not usually deducted from any interest you earn from your savings.

This also applies to interest distributions within some Open-Ended Investment Companies OEICs, Investment and Unit Trusts.

Savings interest is still included as taxable income but the introduction of the ’Personal Savings Allowance’ means that many taxpayers will no longer need to pay tax on savings interest.

This means:

  • basic rate tax payers can earn up to £1,000 interest on their savings without having to pay tax
  • higher rate tax payers can earn up to £500 worth of interest tax-free
  • additional rate tax payers, so those who generally earn more than £150,000 a year, will not benefit from the personal savings allowance.
  • any interest from savings exceeding your ‘Personal Savings Allowance’ is liable to income tax at your highest marginal rate of Income Tax.

If you live in Scotland, the tax rates are slightly different. Find out more on our Scotland Income Tax page.

The Starting Rate for Savings if you’re on a low income

The starting ‘Rate of Tax on Savings’ is aimed at supporting savers on the lowest incomes. For 2018-19 it is £5,000. This means that most people with a total income of less than £17,850, including income and savings interest, will not pay any tax on their savings.

This upper limit is higher if you are claiming the Blind Person’s Allowance (£2,390 for the Tax Year 2018-19) or the Married Couple’s Allowance (which gives an amount that’s dependent on your personal circumstances).

However, in general, unless one of the above applies to you, if you earn over £16,850 the Starting rate of Tax doesn’t apply to you. That doesn’t mean you’ll have to pay tax on savings though.

This is because for every £1 of non-savings income over £11,850, the starting rate goes down by £1. The personal savings allowance, above, adds to these tax-free savings rules, which is why you’ll normally pay no tax on savings if you earn less than £17,850.

This allows you to earn up to £5,000 in savings interest tax free and also pay no tax on up to £1,000 of savings interest as you use up your personal savings allowance.

For example, someone with a salary of £14,500 per year and interest on savings of £150:

Income Personal Allowance Amount earned over the Personal Allowance Remaining amount fo savings interest that can be tax free
£14,500 £11,850 £2,650 £2,350

That means that £2,350 can be earned in interest from savings tax free, so the £150 of interest they have earnt from their savings will be tax free.

The £2,650 of employment income over the standard personal allowance of £11,850 will however still be taxed at 20% (the basic rate of tax) so in this example they will still have an income tax liability of £530 on their employment income and pay national insurance contributions on earnings above £8,424 (for the tax year 2018-19) a year.

For more information on Tax on savings interest visit GOV.UK.

Claiming back tax

If you think you’ve overpaid tax on your savings, you can claim it back by filling in form R40 on GOV.UKopens in new window.

Tax-free savings

Some savings products pay interest that is tax-free- although most savers no longer need to save into an ISA to earn interest tax free, thanks to the introduction of the Personal Savings Allowance.

Your ISA allowance for the 2018/19 tax year is £20,000, meaning you can still save tax free even if you are an additional rate taxpayer.

Tax-free savings products include ISAs and some NS&I products, such as savings certificates and Children’s Bonds (Children’s Bonds are no longer available, but if you already have them you have options. Find out more on our Children’s Bonds page).

Share-based investments

If you own shares, you may get income in the form of dividends.

Dividends are a portion of the profits made by the company that issued the shares you’ve invested in.

If you have an investment fund that is invested in shares, then you may get distributions that are taxed in the same way as dividends.

For the tax year 2018-19 the tax-free Dividend Allowance is £2,000 a year.

Dividends above this level are taxed at:

  • 7.5% (for basic rate taxpayers)
  • 32.5% (for higher rate taxpayers)
  • 38.1% (for additional rate taxpayers).

Any dividends received within a pension or ISA are unaffected and remain tax-free.

Basic rate payers who receive dividends of more than £2,000 need to complete a self-assessment return.

Examples:

  1. If you receive dividend income of up to £2,000 outside an ISA. You will pay no tax on your dividends, even if you are a higher or additional rate taxpayer.
  2. If your total income is less than £11,850 (the current personal allowance), any income is covered by your personal allowance. You will have no tax to pay as your dividend allowance of £2,000 is untouched.
  3. If your dividend income is received within an ISA, it will remain tax-free and the dividend allowance will not impact any income you receive.

Tax-efficient investments

Generally speaking, stocks and shares ISAs are useful if you pay Income Tax at a higher or additional rate. However, it’s a good idea to weigh up the pros and cons if extra charges are involved.

For the tax year 2018-19 the tax-free Dividend Allowance is £2,000

This means that any dividend income above £2,000, received outside of an ISA, will be taxed at:

  • 7.5% for basic rate taxpayers
  • 32.5% for higher rate taxpayers
  • 38.1% for additional rate taxpayers.

Any profit from shares rising in value is completely free of liability for Capital Gains Tax if you hold them through an ISA.

Where the investments in your stocks and shares ISA do not pay dividends, but instead pay interest (for example, government and corporate bonds), the interest paid remains tax-free.

Life-insurance investments

One way to invest in investment funds is through a life insurance policy.

The insurance company owns the funds and has to pay tax on income and gains they make.

When the proceeds are paid out to you, they always count as income and you are treated as if tax at the basic rate of 20% has already been deducted.

This tax can’t be reclaimed. If you don’t pay tax because you earn less than £11,850, or you pay the basic rate of tax, there is no more tax for you to pay.

Higher-rate and additional-rate taxpayers have to pay extra tax of 20% and 25% unless the insurance policy is ‘qualifying’, in which case there is no extra tax.

Policies issued by a UK-based Life office where you pay regular premiums for 10 years or more are likely to be qualifying; policies where you pay a single lump sum premium are not.

Other options

It may make sense to consider other types of investment fund, such as unit trusts and open-ended investment companies (OEICS), rather than life-insurance investments.

With these funds, part of the proceeds you receive count as income (and are typically taxed as described above in the section on share-based investments), while part may come from gains due to rising share prices.

In particular, because you have a capital gains tax-free allowance limit (currently £11,700 for the tax year 2018/19), you could find you might pay less tax if you hold these types of investment fund rather than some life-insurance investments.

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