You can use tax rules to pay nothing in tax on up to £17,500 of savings interest
Savers face hideously complex tax rules on their nest-eggs after years of meddling by different Chancellors.
Money Mail receives a steady stream of emails and letters from readers who’ve been left puzzled.
But you can use the rules to pay nothing in tax on up to £17,500 of income.
You must grapple with no fewer than three allowances, as well as where your income comes from.
The three ‘allowances’ you can claim from the taxman to cut your savings tax bill are the £11,500 personal allowance — the amount most people can earn no matter where the income comes from before paying tax — the £5,000 starting-rate band allowance, and the £1,000 personal savings allowance.
Altogether they total £17,500.
The starting rate allowance
The most muddling is the £5,000 starting rate band allowance.
It was introduced in April 2015 to help savers with lower incomes — such as pensioners, part-time workers, and non-working adults — whose interest takes them above the normal personal allowance.
It is a maximum of £5,000 and given to those whose income other than savings interest is £16,500 or less.
For every £1 of income above the personal allowance of £11,500 from other sources than savings interest, you lose £1 of the tax-free starting rate band allowance.
Where your income comes from matters
If your income (ignoring any interest from cash Isas) is below £17,500, you can pay no tax.
Where your income comes from is crucial to your number-crunching.
If, for example, you have a pension of £15,000 and £2,500 of savings income, all your savings interest is tax-free using the savings allowances. But you still pay £700 tax on £3,500 of your pension (£15,000 minus £11,500) as a basic-rate payer.
However, if your pension was below £11,500 you could earn savings interest that took your total income to £17,500 before you owe any tax.
Even if your total income is slightly above the £17,500 mark, you won’t pay tax on all your interest. You can use some of the £5,000 starting band.
How much depends on how your income is split.
If your pension is £15,000 and savings income £3,000 — a total of £18,000 — you will pay £100 tax (20 per cent on £500) on your interest.
How to work it out
To work out your tax on savings interest, you start with the £16,500 figure (the personal allowance of £11,500 plus the £5,000 starting rate).
Deduct your pension, or work income, which, in the £15,000 example, leaves £1,500. You can then use your £1,000 personal savings allowance. The result is you pay tax on £500.
If you get £16,500 or more from your pension or work, you don’t qualify for any of the starting rate band. But you still get the £1,000 personal savings allowance.
Those whose pension or work income falls below the £11,500 personal allowance get the full £5,000 starting rate, plus the £1,000 savings allowance, so can earn £17,500 tax-free.
How the starting rate band works
The Gov.uk website explains about the starting rate band allowance on savings interest:
If your other income is £16,500 or more
You’re not eligible for the starting rate for savings if your other income is £16,500 or more.
If your other income is less than £16,500
Your starting rate for savings is a maximum of £5,000. Every £1 of other income above your Personal Allowance reduces your starting rate for savings by £1.
It gives this example:
You earn £15,000 of wages and get £200 interest on your savings.
Your Personal Allowance is £11,500. It’s used up by the first £11,500 of your wages.
The remaining £3,500 of your wages (£15,000 minus £11,500) reduces your starting rate for savings by £3,500.
Your remaining starting rate for savings is £1,500 (£5,000 minus £3,500). You don’t pay tax on your savings interest.
What to do if you think you paid too much tax
Your bank, building society and National Savings tells HMRC how much interest you earnt each tax year — but not until November or December, seven months after the end of the tax year in April.
Until then, it bases your tax code on the interest you earned in the previous year.
If it changes, you can ask HMRC to update your tax code.
You can do this online, by post at Pay As You Earn and Self-Assessment, HM Revenue and Customs, BX9 1AS, or by phoning 0300 200 3300 from 8am to 8pm, Mondays to Fridays, and 8am to 4pm on Saturdays.
If you are due a refund, ask for form R40 or download it from hmrc.gov.uk.
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