New tax menace could take a painful bite into YOUR cash

Menace: More than six million savers are facing tax bills on their interest for the first time in seven years

More than six million savers are facing tax bills on their interest for the first time in seven years – and many could be forced to pay hundreds of pounds. The much-ignored tax is expected to hit millions more savers over the next five years.

All savers have a personal allowance, which allows you to earn some interest on your savings tax free. Basic rate taxpayers can earn up to £1,000, and higher rate taxpayers can earn £500. Additional rate taxpayers have no allowance and therefore pay tax on all of their interest.

For years, savers were earning so little interest that their personal savings allowance was generous enough to ensure only the very wealthiest ever paid tax.

But as interest rates rise, even savers with relatively small nest eggs could breach their allowance. Older savers in particular, who rely on their savings for an income, risk running up tax bills.

Sarah Coles, of wealth platform Hargreaves Lansdown, says that although higher interest rates are welcome for beleaguered savers who have had to put up with ‘miserable rates’ for more than ten years, ‘they will push more savers into paying tax for the first time since the personal savings allowance was introduced in April 2016.’

Savers paid £3.4 billion in tax on their savings last year, according to wealth platform AJ Bell. This is nearly three times higher than the previous year.

Why are tax bills growing?

Savings rates are at a 14-year high, with the top one-year fixed bond paying 5.25 per cent (see best buy tables – Page 66). That means a basic rate taxpayer, earning under £50,270, would breach their allowance if they had just over £20,000 of savings in a top-paying account.

A higher rate taxpayer, earning between £50,271 and £125,140, only needs to have just over £10,000 in the same account to breach their allowance. An additional rate taxpayer, earning over £125,140, would pay tax on all of their savings interest.

Just a year ago, savers could have had balances twice as high as today without having to pay tax. That is because the top rate available was just 2.4 per cent.

When the personal savings allowance was first introduced in 2016, a basic rate taxpayer could hold as much as £68,966 in a top-paying account without paying a penny of tax, according to Anna Bowes, of Savings Champion. The best-paying account at this time only paid 1.45 per cent interest.

Once you have breached your personal savings allowance, you pay tax on interest at your income tax rate. Therefore basic rate taxpayers pay 20 per cent, higher rate pay 40 per cent and additional rate pay 45 per cent tax.

UK households have £13,954 in conventional savings accounts, according to Hargreaves Lansdown. This would be more than enough to breach the allowance if largely held by a higher or additional rate taxpayer.

The amount of tax owed by savers will continue to rise as savings rates climb higher. Growing numbers of workers will also see their bills spiral as they are dragged into a higher rate tax band. Income tax thresholds have been frozen until at least April 2028. As a result, a further 2.6 million workers will become higher rate taxpayers and shall see their personal savings allowance halve to £500.

– Check out the best easy-access savings rates here.

How will you be billed?

If you are employed or receive a pension, HM Revenue & Customs will automatically change your tax code and take the tax from your earnings. 

To calculate your code, it will estimate how much interest you will get in the current year by looking at the amount you got last year.

If you complete a self-assessment tax return, for example if you are self-employed, you must report any interest earned on savings on your form. 

If none of the above applies, your bank or building society with tell the taxman how much interest you were paid at the end of the tax year. HM Revenue & Customs will then inform you if you have a bill to pay.

6 ways to cut your tax

1) Shelter your savings in an Isa

The easiest way to shield your savings from tax is sheltering them in an Individual Savings Account (Isa). This is much like other types of savings account, except all interest earned is tax free. You can pay up to £20,000 into an Isa every tax year.

Isas tend to pay slightly less interest than standard savings accounts. The average one-year fixed rate Isa pays 3.95 per cent, while the equivalent standard account pays 4.18 per cent. 

However, if you are at risk of breaching your personal savings allowance, you may be better off taking a slightly lower rate and opting for an Isa. For example, a higher-rate taxpayer with £15,000 in savings would earn £592.50 in the Isa above, but £576.20 in the standard savings account, once £50.80 in tax had been deducted.

Mail on Sunday reader Peter Vincent, from Tunbridge Wells, realised last week that he was heading for a tax bill on his savings for the first time this year unless he acted quickly. He was set to breach his £1,000 personal savings allowance by £400, which would have landed him an £80 tax bill.

However, after a conversation with his son-in-law, the 78-year-old opened a one-year fixed rate Isa with Nationwide, paying 4.1 per cent, and transferred his savings. Peter’s money will now be shielded from tax. 

He will also earn more interest because his Isa pays a better rate than the accounts where he previously held his savings. These were an HSBC Premier Savings paying just 1.6 per cent and a Nationwide current account paying 3.2 per cent.

‘We heard about this savings tax a long time ago but everyone has forgotten it exists because rates have been so low for so long,’ he says. ‘It’s so easy to fall into the trap if you leave your savings where they are.’

Millions of savers like Peter are waking up to the value of Isas. A record £11 billion was paid into them in April. In the same month, savers pulled £4.5 billion out of standard instant-access savings accounts, which are not sheltered from tax.

– Check out the best fixed rate savings deals here. 

2) Claim extra allowances if you’re a very low earner

UK adults have a personal allowance, which enables people to earn up to £12,570 tax-free.

If you have not used up this allowance through your wages, pension or other income, you can use it towards interest earned on your savings.

This is in addition to your personal savings allowance.

If you earn less than £17,570, you could also accrue up to £5,000 of interest without paying tax on it. This £5,000 allowance is known as your starting rate for savings.

To see how these three allowances work together to reduce your tax bill, go to: gov.uk/apply-tax-free-interest-on-savings

3) Hand money to your spouse

If you are in a higher rate tax band than your spouse, you could cut your tax bill by holding your joint savings in his or her name.

A basic rate taxpayer and a low or non-earning spouse could have a combined personal savings allowance of £7,000.

If you hold your savings in a joint account, interest will be split equally between the account holders.

4) Use Premium Bonds

Premium Bonds with National Savings and Investments (NS&I) can be a good shelter for your cash if you fear breaching your personal savings allowance.

All prizes are paid tax-free and do not count towards your savings or income tax allowances. You can put anything from £25 to £50,000 into Premium Bonds and stand a chance of winning up to £1 million. The current prize rate is 3.3 per cent. However, there is a chance you will win nothing.

Savers poured £3.5 billion into NS&I accounts in March alone – nearly double the amount paid in in February. A further £1.6 billion went into these accounts in April.

But beware: interest earned in NS&I’s direct saver account and income bonds does count towards your personal savings allowance.

5) Shelter your child’s savings in a Junior Isa

Children have an even lower personal savings allowance than adults. Any savings interest earned above £100 a year is taxed as if it belongs to the parent. This is to prevent parents avoiding tax by holding their own savings in the name of their child.

It means that if a parent has already used their own personal savings allowance, their child’s savings will be taxed at the parent’s tax rate as soon as they earn above £100 in interest.

If you are saving for a child, you can opt for a Junior Isa, which shelters savings of up to £9,000 a year from tax.

6) Pick a multi-year bond that pays interest annually

Some multi-year fixed rate bonds pay interest every year, while some distribute all the interest at the end of the term. If you are at risk of breaching your personal savings allowance, opt for the former.

That way, you can use your personal savings allowance to reduce your tax bill every year, rather than just once at the end of the term.

For example, a basic-rate taxpayer who puts £15,000 into a five-year fixed rate account paying a top rate of 5.1 per cent would earn £4,235 interest. If the interest was paid out every year, they would stay under the personal savings allowance threshold and have no tax to pay.

But if it was all paid out at once, they would have no tax bill for four years and then a £647 bill in the fifth. A higher rate taxpayer would pay £800 more in tax if they receive all the interest at once instead of annually.

According to Revenue & Customs, if you can request to take the interest each tax year, then the earnings are deemed to be received annually, even if you don’t receive the payments until the end of the term. However, for deals that don’t allow you to take the interest each year, you are likely to be taxed in one go at the end of the bond’s lifetime.

Bowes, of Savings Champion, says: ‘It can be difficult to be sure of which type of bond you are opening but it could have a huge impact on how much tax you have to pay.

‘The problem is that you may need to get clarification from a tax expert, as this can be quite a complicated area and it’s not always immediately obvious if it may be due only at maturity.’