The personal savings allowance is a benefit that applies to almost every taxpayer in the UK, which makes it much less likely that you’ll pay any tax on the interest you earn from your savings.
Here’s how it works.
How does the personal savings allowance work?
The personal savings allowance is really simple. There are three bands of income tax in the UK, the basic rate, the higher rate and the additional rate. If you’re on one of the first two bands, you don’t have to pay income tax on a huge slice of the interest you earn.
- People on the basic rate of income tax – anyone who earns up to £50,000 in 2020/21 – pay no income tax on the first £1,000 of interest they earn on their savings.
- Those on the higher rate – earning between £50,000 and £150,000 in 2020/21 – pay no income tax on the first £500 of interest they earn.
- If you earn more than £150,000 per year on the additional rate, you are not eligible for the personal savings allowance and have to pay income tax on all the interest you accrue
If you do earn more interest than is covered by the personal savings allowance, you have to pay income tax on the remainder at your standard rate – either 20% or 40% depending on the band. However, for this to kick in at the current levels of interest, you’d have to have a very large amount of money saved up.
HMRC estimates that around 95% of the country are either on the basic rate or higher rate of income tax, and can benefit from the personal savings allowance.
Where does the personal savings allowance apply?
The PSA applies to any interest you earn in a year, including interest from the following sources:
- Bank and building society accounts
- Savings and credit union accounts
- Unit trusts, investment trusts and open-ended investment companies
- Peer-to-peer lending
- Trust funds
- Payment protection insurance (PPI)
- Government or company bonds
- Life annuity payments
- Certain life insurance contracts
So, for example, if you win £100 from Premium Bonds and receive £100 in ISA interest, you’ll still have your £1,000 personal savings account to cover any other interest you might earn.
How much can I save before I go over the allowance?
How much you can save depends on the account of savings account and how much interest it pays.
For example, a basic-rate taxpayer with a savings account that pays interest at 1% would need to have more than £100,000 in it for the whole year before it generated enough interest to use up their personal savings allowance.
A higher-rate taxpayer could save half that amount, at £50,000, before their allowance was used up.
How do I claim the personal savings allowance?
The good news is you don’t have to do anything to claim the allowance.
Interest is now paid straight into your account with no tax taken off, so it all happens automatically. If the interest you earn exceeds the personal allowance, then any tax you owe will be paid to HM Revenue and Customs (HMRC) through your tax code.
If you fill in a self-assessment tax return, then you will repay any tax owed this way instead.
Is there any benefit still saving into cash ISAs?
ISAs are a special type of savings account that give you a much higher tax-free threshold of up to £20,000, so they work in a similar way to the PSA.
Although you need a large amount of savings to use up your personal savings allowance, bear in mind that if interest rates start to rise, you may need to save much less to reach the £1,000 or £500 threshold.
How does income tax work?
Income tax is tax you pay on your earnings. It’s usually automatically deducted from your paycheck, but freelancers have to calculate it themselves.
In the 2020/21 tax year, the first £12,500 of everyone’s income is not taxed – unless they earned more than £100,000.
For anyone earning more than £12,500 there are three bands of income tax.
- Basic rate: Anyone who earns between £12,500 and £50,000 a year pays income tax of 20% on everything they earn aside from the first £12,500.
- Higher rate: If you earn between £50,001 and £150,000, you pay 20% tax on anything you earn up to £50,000, and then 40% on anything you earn up to £150,000. The first £12,500 is tax free unless you earn more than £100,000 – in this case, your tax-free allowance falls by £1 for every £2 your salary goes over £100,000
- Additional rate: Those who earn £150,001 or more every year pay 20% of the first £50,000, 40% of the next £100,000, and then 45% of everything they earn on top of that
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