Date posted: 4th Nov 2022
As interest rates continue to increase to levels not seen since 2008, there may be a potential knock on tax impact for those with savings.
In 2008, the banks would automatically deduct 20% tax from any interest paid to customers. This usually meant that there were no further tax implications for savers, unless you were subject to higher rates of tax.
However, since April 2016, the banks no longer deduct the basic 20% tax at source. Due to interest rates being so low and the introduction of savings allowances which allow an amount of interest to be received tax free (£1,000 for basic rate taxpayers, £500 for higher rate taxpayers but £0 for additional rate taxpayers), there has likely been little interest to report to HMRC unless you had at least a decent amount of savings.
However, now those with more modest savings could be caught with a tax charge on the interest received due to increasing interest rates.
In addition, the interest income may also impact upon other issues such as level of income for child benefit, pension tapering, personal allowance entitlement and so forth.
Example 1 – basic rate taxpayer
John earns £35,000 and no other sources of income.
John has recently inherited £40,000 from his father. John decides to transfer his £40,000 into a savings product paying 5% interest. In simple terms, John will receive £2,000 of interest per annum.
John is a basic rate taxpayer as his total income of £37,000 (£35,000 + £2,000) does not exceed the higher rate threshold of c£50,000. Therefore, as a basic rate taxpayer, John is entitled to a savings allowance of £1,000. So £1,000 of John’s interest is not subject to income tax. However, there is £1,000 on which John is then subject to income tax at 20% – so John owes £200 to HMRC.
If John is married, then he could make tax savings by transferring the monies into joint names, assuming his spouse has no savings of their own. He could also save some of the monies into a tax free wrapper such as an ISA.
Example 2 – higher rate taxpayer
Sylvia has a state and private pension of £40,000. Sylvia is a widow with £500,000 of savings. Like John, she has invested her £500,000 into a 5% saver, which returns £25,000 of interest.
Sylvia is a higher rate taxpayer as she has income of £65,000 (£40,000 + £25,000). She is entitled to a savings allowance of £500. This means that whilst £500 is subject to 0% tax, the other £24,500 is not. Sylvia will therefore owe HMRC 40% of £24,500 i.e. £9,800 in tax on the interest. Sylvia will need to declare the income to HMRC on a tax return, due to the amounts involved.
If Sylvia is not aware of the need to submit a tax return to HMRC for a number of years, then she could be accruing a large unforeseen tax bill with potential penalties for not filing tax returns with HMRC.
Example 3 – £100k income
Janette is a corporate executive earning £100,000.
Janette has £40,000 in savings and similarly to John and Sylvia, invests this into a 5% saver, returning £2,000 of interest.
As Janette has total income of £102,000 she is only entitled to a savings allowance of £500. Thus £1,500 of interest is subject to tax at 40% – £600. However, as Janette’s income is over £100,000, she loses some of her personal allowance entitlement. She will lose £1,000 of her standard personal allowance entitlement, which creates a further £400 tax charge. Thus Janette has paid £1,000 tax due to receiving £2,000 of interest – a 50% tax rate.
Janette may also lose the ability to claim tax relief on any childcare costs.
Example 4 – £150k income
Sam is self employed and earns £150,000 per annum.
Sam has £100,000 in savings. Again, she invests this in a 5% interest bearing saver, returning £5,000 of interest. As Sam earns over £150,000, she is not entitled to any savings allowances and will need to pay 45% tax on her interest – £2,250.
The interest rate rises should be seen as good news for savers but they need to be aware of tax consequences of receiving levels of interest that they may never have received previously or if they have, certainly for a number of years.
As ever, we are able to help you comply and plan for any tax liabilities. Please contact us if you have any queries.