Savers have been grumbling about paying tax on their interest for years. Under new rules, more than nine out of 10 savers will are no longer pay income tax on their savings interest, only the very wealthy will remain in the firing line. The problem is that the rules are complex and you could end up paying tax by mistake.

Personal savings allowance

On 6 April 2016, the new personal savings allowance finally came into force. Under the allowance, announced by Chancellor George Osborne in his March 2015 budget, basic-rate taxpayers can earn up to £1,000 interest a year without paying income tax. 

That falls to £500 for 40% taxpayers, but additional rate 45% taxpayers—those earning £150,000 a year or more—do not qualify.

The allowance doesn't only apply to money held in bank and building society accounts. It also covers savings held in credit unions and National Savings & Investments, income from Government and corporate bonds, and most types of purchased life annuities.

This means a basic rate taxpayer could hold £66,666 in a bank account at 1.5% before paying any tax on the interest while higher rate taxpayers can have £33,333.

However, savings rates won’t be this low forever. If rates hit 5%, a basic rate taxpayer would pay income tax on savings above £20,000, falling to just £10,000 for a higher rate taxpayer.

It may still be worth using your individual savings allowance (ISA) as well, using a cash ISA. This allows you to save up to £15,240 in the current tax year and take all your interest-free of tax.

 

Dividend allowance

The new dividend allowance also launched on 6 April, allows every investor to take the first £5,000 of income from company dividends free of tax, regardless of their tax bracket.

This comes on top of your personal allowance, which rose to £11,000 at the same time. So you could earn £16,000 a year free of tax, or £17,000 for basic rate taxpayers using their £1,000 personal saving allowance.

The downside is that dividends above this limit will be subject to higher tax rates than before.

Tax will be charged at 7.5% for basic-rate taxpayers, who paid nothing before. It will rise to 32.5% for higher-rate taxpayers and 38.1% for additional rate taxpayers.

To avoid those punitive tax rates, invest inside the stocks and shares ISA tax wrapper where possible, where your dividend income and capital growth will be free of tax for the rest of your life.

Your spouse or civil partner can even inherit your ISA benefits free of tax when you die, although your children ultimately cannot.

 

Low-interest rates and volatile stock markets have made life hard for savers, but with a bit of careful planning at least you shouldn't have to worry about HM Revenue & Customs making life even more taxing.

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