What is the personal savings allowance and what does it mean for you?

What you’ll learn:

• How savings income was taxed previously
• How the PSA works
• What affect the PSA has on cash ISAs.

The personal savings allowance (PSA) was introduced on 6 April 2016, which meant that the majority of savers in the UK no longer had to pay any tax on a portion of their savings income.

Basic-rate taxpayers qualify for a £1,000 PSA. This means they can receive up to £1,000 a year in savings income tax-free.

Higher-rate taxpayers have a PSA of £500 a year. So they can earn £500 a year in savings income before they have to start paying tax on it.

Additional rate taxpayers don’t have a PSA and must pay tax on any income they get from savings that aren’t in a stocks and shares ISA or cash ISA.

A basic-rate taxpayer, for example, would only go over the annual £1,000 PSA limit if they had more than £100,000 in savings, assuming they were earning interest at a rate of 1.00% and earning no interest from other sources. Based on the same rate of interest, someone in the higher-rate tax band would be liable for tax if their savings totalled more than £50,000.

Investors also have a dividend allowance, which means that individuals receive their first £500 in dividends tax-free. Any above this amount will be charged at 8.75% for basic rate taxpayers, 33.75% for higher-rate taxpayers, and 39.35% for additional rate taxpayers.

How did savings income used to be taxed?

Before April 2016, you could have had to pay tax on any savings income you earned.

Tax of 20% was automatically deducted on certain savings income, such as interest from the bank and building society accounts, and interest distributions from investment funds, such as authorised unit trusts (AUTS) and open-ended investment companies (OEICS). This meant basic-rate taxpayers had no more tax to pay. However, higher-rate taxpayers and those in the additional rate tax band had to pay the extra tax they owed when they completed their annual self-assessment tax return.

Non-taxpayers could arrange for bank interest on their current accounts and deposit accounts to be paid gross, so no tax was deducted, by completing an R85 form. This was the same for children’s savings.

The only tax-free options were ISAs.

Do I pay tax on my savings interest because it exceeds the PSA?

Since the introduction of the PSA, banks and building societies have stopped deducting 20% tax from bank interest, so it is now paid gross. Non–taxpayers no longer need to complete an R85 form to receive their bank interest gross. However, tax continues to be deducted automatically from certain other forms of savings income, such as interest paid by a company that isn’t a bank.

HMRC has said that tax from savings income is collected via the pay as you earn (PAYE) system in the majority of cases. Some people may still have to declare it on their self-assessment tax return or pay it by other means, however. More information on this is available on the HMRC website.

As well as interest on cash savings accounts, what else is classed as savings income?

The PSA applies to returns classed as savings income. This includes:

• Interest from bank and building society accounts
• Interest from accounts with providers such as credit unions and National Savings & Investments
• Interest distributions (not dividend) from AUTs, investment trusts and OEICs
• Income from corporate bonds and gilts (government bonds)
• Purchased life annuity payments

What does the PSA mean for cash ISAs?

ISAs have become a popular option for savers, as returns on investments within them are tax-free, but the PSA presents another way to get some tax relief.

If you’re saving into stocks and shares, there’s also the divided allowance.

However, the PSA and divided allowance don’t mean ISAs are now redundant. They’re still worth considering as part of your overall savings and investments portfolio.

Please remember the above is a guide only and we don’t provide tax advice. Please consult the HMRC website or a personal tax adviser for further detail.

The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.