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Tax on savings in the UK: make your savings tax efficient

Are you aware of what tax on your savings you might have to pay? Do you know what your personal savings allowance (PSA) is? For the answers to what tax on savings UK citizens might face and other questions relating to savings and investments, please read on.

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Your personal savings allowance

An excellent place to start when looking into savings and taxation is with the UK Personal Savings Allowance, or PSA for short.

Following the introduction of the PSA in April 2016, which allows many people to earn up to £1,000 by way of interest without having to pay tax, less than 5% of savers are liable.

The UK PSA covers any interest you might earn from savings in various accounts, including bank or building society accounts, credit union accounts, corporate bonds, government bonds and gilts, and savings accounts. In addition, if you have any foreign currencies in a UK-based savings account, these too are covered. Income from ISAs, however, is not.

Tax-free savings and the starting rate for savings

You will pay 0% UK income tax on savings interest if your combined income and savings interest earned total are £18,750 or less in one tax year. The figure of £18,750 is made up of three separate components.

The first component is the basic income tax allowance which is £12,750.

The second component, set up for low earners, is what is known as the starting rate for savings, and this is £5,000.

The third element is the personal saving allowance UK citizens are entitled to, which is £1,000 per annum for basic taxpayers.

The UK savings allowance can go above £18,750 if you receive specific allowances such as blind person’s or marriage allowance. In addition, your employer or pension provider is made aware of how much tax-free income you are entitled to by the tax code HMRC gives you.

You can find more information about increased UK tax on savings interest allowances on the Gov.UK website.

How to calculate your potential tax savings

To calculate your potential tax savings, you take your starting rate for savings, which for low earners is £5,000, and for every pound of income over your personal tax allowance, you take one pound from the £5,000 starting rate.

If you earn £16,000 per annum and your personal tax allowance is £12,750, the difference is £3,250. Subtract this from your £5,000 starting rate, and the balance of your starting rate is £1,750. But you also have your personal saving allowance of £1,000, taking your revised balance for your starting rate for savings tax to £2,750. Anything below is not taxable.

Has the PSA made ISAs less attractive?

Before the PSA was introduced in 2016, you had to pay income tax on any interest earned on your savings. So, ISA tax wrappers were created and were first introduced in 1996, a clear preferential choice. But after the PSA came into existence, it did lessen the attraction of ISAs for many people, particularly those with smaller saving pots, while interest rates remain so low.

However, when interest rates start to climb, as they are now doing, savers will reach their PSAs that much quicker. It means that for savers investing in the long term and looking to shelter as much as their savings as possible from the taxman, ISAs are still an attractive vehicle.

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Cash ISAs versus stocks and shares ISAs

Your investor profile defines your preferences when it comes to financial decisions, whether you are risk-tolerant or risk-averse, or whether you prefer short or long-term trading.

For risk-averse individuals, the Cash ISA is often the chosen vehicle. But the penalty for the safety of your savings or investments is the low interest they will earn.

Stocks and Shares ISAs, on the other hand, earn interest at significantly higher rates than Cash ISAs. However, you must be aware that the value of your investment can fall and rise. But the main attraction is that Stocks and Shares ISA taxes are virtually non-existent – no income or capital gains taxes apply.

Another feature of saving in stocks and shares is that there is also a dividend allowance. You can receive dividend income of up to £2,000 per annum tax-free.

The big attraction of Stocks and Shares ISAs are that they are tax-free savings accounts UK investors can take advantage of, even when their investment portfolio is worth hundreds of thousands of pounds.

Pensions and taxation

Is pension income taxable? Regrettably, it is. Whatever type of pension you have, a workplace defined benefit or defined contribution scheme, or any other private pension or SIPP, HMRC demand their share of the spoils.

If you wish to carry on working after reaching the state pension age, you can do so. You can also take your pension, but if you do, both your pension income and your employment income are taxable. But while any income above your tax and savings allowance is susceptible to income tax, you don’t have to pay National Insurance.

Although pension contributions are taxable, you can claim tax relief. In terms of reducing income tax on UK pension contributions, basic taxpayers can claim 20% relief, higher rate taxpayers, 40%, and additional rate taxpayers, 45%.

With workplace pensions, your employer automatically claims the first 20%, so you don’t need to claim it yourself. But you do need to claim relief on contributions above 20%, so it is imperative to understand pension tax relief for high earners fully.

You make pension contribution tax relief claims by completing a self-assessment tax return. If you have to complete a self-assessment form, you need to be aware of the UK tax year dates 2022.

Employers can use one of two methods for dealing with pension contribution tax relief – relief at source or paid gross. Either way, they will automatically claim the first 20% on your behalf.

In Scotland, the same relief structure applies. If you are a 19% basic rate taxpayer, your employer will still claim 20% pensions contribution tax relief.

Pension scams

The risk of being scammed by unscrupulous individuals or companies who are out to steal your pension savings is high. To ensure you are dealing with a bona fife person or business, ensure they are authorised and regulated by the FCA (Financial Conduct Authority). The same applies to any investment vehicle such as ISAs,

Conclusion

Having read through this article, we hope that you are now more aware of how to make the best use of your UK tax-free savings allowance and that you appreciate how your savings income is taxed.

But please be very wary when speaking to anybody about your pension, regardless of the nature of the discussion. If the Financial Conduct Authority does not regulate whomever you are communicating with, do not follow their advice.

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