Personal Savings Allowance : How Does It Work?

Starting from this coming April the way tax is collected on savings interest is changing. In this guide we break down exactly what you need to know.

The old system

At the moment (pre-April 2016), Banks and Building Societies deduct tax on any interest paid out to savers at source - meaning that, in general, the basic rate of tax is taken off any interest paid. So that's 20 percent taken off the GROSS amount - so what is paid into accounts is the NET interest.

This system required additional paperwork and hassle for people who either:

• Earned nothing but savings interest - so should be able to accrue up to £5,000 in interest per year tax free.
Are higher rate taxpayers and therefore should pay tax on interest at the higher rate (40%).

In the first case, Banks/Building Societies would need to be informed to stop deducting tax on interest payments. In both of the above cases additional paperwork must be filed to HMRC to notify them of the situation.

The new system

From April 2016 there will be a new personal allowance provided solely for use against savings interest income. It will be tiered as follows:

1. £1,000 tax free savings personal allowance for basic rate taxpayers.
2. £500 tax free savings personal allowance for higher rate taxpayers.

In order for the new system to work one major change is that Banks/Building Societies will pay interest to accounts GROSS - no basic rate tax will be deducted at source..

Alongside the new allowance, savings interest will be classified as:

• Interest from Banks/Building Societies.
• Accruals within Credit Unions or NS&I (National Savings and Investments).
• Interest distributions from Unit Trusts, OEIC (Open-ended Investment Companies) and Investment Trusts.
• Government or Company Bond income.
• Life Annuity payments.

What is my Personal Savings Allowance?

From April 2016, the basic tax free personal allowance is £11,000. On top of this there is the zero percent starting band for savings up to £5,000. In addition there is the £1,000 personal savings allowance - £1,000 for basic rate taxpayers or £500 for higher rate taxpayers. All in all if you have a taxable income of less than £17,000, there is no further tax to pay.

Essentially, depending upon your non-savings income you start off with a £5,000 zero rate tax band. This band is then extended by the personal savings allowance amount, which is determined if you are a basic or higher rate taxpayer. The zero rate band created is taken out of the basic rate band so that is shortened but the amount taken out is taxed nothing. A little complicated but an example would be as follows:

1. You have £5,000 of savings interest income in 2016 and £25,000 income from employment.
2. Your employment income is taxed first after subtracting the £11,000 personal allowance. This means £14,000 is taxed at the basic rate of 20%. The £14,000 is taken from your basic rate band (£32,000), of which £18,000 then remains.
3. As the non-savings income exceeds the starting rate limit of £5,000 it does not apply to your savings. However, the new personal savings allowance does and as a basic rate taxpayer you receive an allowance of £1,000.
4. The £5,000 savings are taxed as follows. The first £1,000 is covered by the personal savings allowance at zero percent. The remaining £4,000 is taxed at the basic rate of 20%, so £800 is taxed.
5. The full £5,000 is taken out of the remaining basic rate band - so only £13,000 is carried forward to be used against any other remaining income sources.

The easiest way to get an estimate of what your total tax liability for the tax year would be is to use our Tax Wizard. Savings are treated as one of the top slices of your total earnings for tax purposes, so our calculator will determine the percentage of tax to take from each earning type in steps.

Notifying HMRC

HMRC are collecting information regarding the defined interest payments directly from the respective institutions. If you would like to clarify savings income figures, this can be done using the Self Assessment Tax Return. HMRC are planning on collecting the savings tax due by adjusting tax codes.