How To Pay Zero Tax On Your Savings Interest This Year AB Money Website hero

No one likes paying tax. So, here’s how to pay less tax – potentially none at all – on your savings interest.

In theory, interest earned on savings in the UK is taxable. But there are various tax-free allowances you can use to reduce the tax you pay. Unless you’re on a super-high income, or have well into six figures in savings, you can usually reduce the tax on your savings interest to zero.

First of all, almost everyone in the UK is entitled to a personal savings allowance (PSA). This is pretty new – it was introduced in April 2016 – so you might not have heard of it. 

The PSA is the amount of savings interest an individual can earn in a year without having to pay tax on it. For many people it will mean the end of tax on savings interest altogether.

The PSA is set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. But bad luck if you’re classed as an additional rate taxpayer because you earn more than £150,000 a year – you don’t benefit from the PSA.

Record low interest rates mean you'd need tens of thousands of pounds in savings before the PSA even comes in to play. For example, the best easy access savings accounts currently pay about 0.4%. So, a basic rate taxpayer would need to have £250,000 saved before they paid tax on the interest, and a higher rate taxpayer £125,000.

"In theory, interest earned on savings in the UK is taxable. But there are various tax-free allowances you can use to reduce the tax you pay. Unless you’re on a super-high income, or have well into six figures in savings, you can usually reduce the tax on your savings interest to zero."

Emma Lunn, Personal Finance Journalist

If you earn more interest than your PSA, you’ll pay tax on it at your usual rate of income tax.

Got more cash stashed in a savings account than the amounts covered by the PSA? If so, an ISA is your friend. Every adult in the UK, regardless of their income, can pay up to £20,000 into an ISA each year. Returns from an ISA (interest on cash, and dividends or capital gains on investments) is paid tax-free.

There are various types of ISA. The most common are Cash ISAs, Stocks and Shares ISAs, Innovative Finance ISAs. and Lifetime ISAs.

A Lifetime ISA (which can be cash or stocks and shares) can only be opened by people aged between 18 and 39. It’s designed to help you save towards either your first home or your retirement. There’s an annual contribution limit of £4,000 – but the government will reward you with a 25% bonus (so a maximum bonus of £1,000 a year) each year until you hit 50.

If you withdraw money in a Lifetime ISA for any other reason other than to buy a property or retire, you’ll pay a 25% penalty for withdrawals.

Elsewhere you can decide how you use your ISA allowance. For example, you might pay the full £20,000 into either a Cash ISA or a Stocks and Shares ISA; or you might divide your £20,000 allowance across different types of account. However, you can only pay into one of each type of ISA in each tax year.

If you’re an additional rate taxpayer, an ISA should be your first port of call for your savings, as you don’t get a PSA. They are also a good bet for higher rate taxpayers with high savings balances. 

At the other end of the income scale, if you’re on a low income you’ll benefit from the ‘starting rate for savings’. You will qualify for this if you earn less than £12,570 from your job. The starting rate for savings provides an initial buffer before you use your personal savings allowance. It is set at £5,000 for the 2021/22 tax year. For every £1 you earn from other income over the personal allowance of £12,570, your starting rate for savings decreases by £1. 

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