How do I spend my tax-free savings income?
There are various ways to enjoy savings income tax-free. However, not all routes are open to all taxpayers – the options depend on the nature of the savings and the saver’s other earnings and marginal rate of tax.
Basic and higher rate taxpayers are entitled to a savings allowance. The allowance is set at £1,000 for basic rate taxpayers and at £500 for higher rate taxpayers. The allowance is available in addition to the personal allowance and also the dividend allowance. Taxpayers who pay tax at the additional rate (which applies to taxable income in excess of £150,000) do not benefit from a personal savings allowance and must pay tax on any savings income unless it is otherwise exempt.
There is no need for a separate savings allowance for savers who total income is less than their personal allowance as the personal allowance will shelter any savings income.
Savings starting rate
Savings income which falls within the savings starting rate band is taxed at the savings starting rate of 0%. Depending on the individual’s personal circumstances, they may be able to enjoy up to £5,000 of savings income tax-free.
The savings starting rate band is set at £5,000, but is reduced by any taxable non-savings income. This is other taxable income in excess of the personal allowance (but excluding any dividends which are treated as the top slice of income). Consequently, the full £5,000 savings starting rate band is available where other taxable income is less than the individual’s personal allowance. The standard personal allowance is £12,570 for 2022/23. The savings starting rate is eroded once taxable income in excess of the personal allowance reaches £5,000.
The savings starting rate is applied before the personal savings allowance.
If savings are held within a tax-free wrapper such as an Individual Savings Account, the associated savings income is tax-free.
Marion has a state pension of £11,000 a year. She has considerable savings which generate interest of £9,000 a year. She also receives interest of £200 a year from savings held in an ISA.
As her total income of £11,000 is less than her personal allowance of £12,570, the remainder of her personal allowance is available to shelter the first £1,570 of her savings allowance.
Her pension (her only other taxable income) does not exceed her personal allowance; consequently, she is entitled to the full £5,000 savings starting rate band. Savings falling within this band are tax-free (attracting the savings starting rate of 0%).
She is also able to benefit from the personal savings allowance, which is £1,000 because she is a basic rate taxpayer. The remaining interest (other than that from her ISA) of £1,430 (£9,000 – £1,570 – £5,000 – £1,000) is taxed at the basic rate of 20%. The interest of £200 from her ISA is tax-free.
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