Do you pay tax on Interest on savings?
All interest you receive is taxable unless it is from an ISA, but banks and building societies no longer deduct tax from interest paid to individuals. For most taxpayers the rate of tax payable on that interest is 0%, so no tax is in fact due.
This zero tax rate applies where your savings income falls within your Savings Rate Band (SRB), which is worth up to £5,000, or within your Personal Savings Allowance (PSA), which is worth £1,000 for basic rate taxpayers or £500 for higher rate taxpayers. Any savings income which falls outside the SRB or PSA is taxed at your marginal Income Tax rate (currently 20%, 40% or 45%).
The available SRB depends on how much other taxable non-savings income you receive, such as salary, pensions, trading profits or rent. If you can control the type of income you receive, you can
reduce the total tax you pay for the year.
ACTION POINT!
Review your mix of income to maximise your Savings Allowance for 2020/21.
Example
Harry has £150,000 of capital deposited in a bank at 1%, so he receives £1,500 of interest per year. After deducting his Personal Allowance from his salary of
£17,500 he has £5,000 of taxable income, which is deemed to eat up his SRB. He is a basic rate taxpayer, so has a PSA of £1,000.
2020/2021 Non savings Savings Tax payable
Salary/Interest £17,500 £1,500
Personal Allowance (12,500)
Taxed @ 20% 5,000 1,000
PSA (1,000)
Taxed @ 20% 500 100
Total tax payable 1,100
Harry lends £150,000 to his company, which pays him interest at a commercial rate of 3.5% (i.e. £5,250) under a written agreement. The company uses the money for developing a business property. Harry also reduces his salary to £13,750, so that his total income is still £19,000. Reducing his salary frees up some starting rate band to set against his interest income – see below.
2020/2021 Non savings Savings Tax payable
Salary £13,750
Interest 5,250
Personal Allowance (12,500)
Taxable @ 20% 1,250 250
5,250
SRB (5,000-1,250) (3,750)
PSA (1,000)
Taxable @ 20% 500 100
350
Harry’s tax bill has been reduced from £1,100 to £350 on the same level of income. The company must deduct tax at 20% from the interest it pays him but this can be
reclaimed by Harry.