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The new Personal Savings Allowance

The new Personal Savings Allowance (PSA), which came into effect on 6 April 2016, means the majority of individuals are now exempt from paying tax on their savings income. This article explores the new allowance in more detail.

How it works

A 0% rate, known as the ‘savings nil rate’, is applied to savings income within an individual’s PSA. The amount of PSA an individual is entitled to will depend on his or her adjusted net income. The PSA allows basic rate taxpayers to earn up to £1,000 each year in tax-free savings income (such as interest), while higher rate taxpayers can receive up to £500 before paying tax on their savings income. However, additional rate taxpayers have a PSA of nil, meaning they do not benefit from this latest measure.

Following the introduction of the PSA, banks and building societies no longer automatically deduct tax from account interest they pay to customers. Therefore individuals who are unlikely to have tax to pay on their bank or building society interest are no longer required to register with their account provider to have this interest paid without deduction, rendering form R85 obsolete.

What counts as savings income?

Savings income refers to interest from bank and building society accounts, as well as accounts held with credit unions or National Savings & Investments. It also includes interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts. Income from government or company bonds and most types of purchased life annuity payments are also classed as savings income.

Income from an ISA, and income which qualifies for the 0% starting rate for savings (see later), will not use up any part of an individual’s savings allowance.

Income that falls within an individual’s PSA will still count towards their basic or higher rate limits. This may therefore affect the level of PSA they are entitled to, and the rate of tax that is due on any savings income they receive in excess of this allowance.

Interaction with the 0% starting rate limit

The PSA operates alongside the 0% starting limit for savings, which was introduced in April 2015. The 0% starting rate applies for savings income up to the starting rate limit of £5,000. The rate is not available if taxable non-savings income (broadly earnings, pensions, trading profits and property income) exceeds the starting rate limit.

The PSA legislation confirms that the starting rate will not use up any part of an individual’s PSA. However, the starting rate for savings does use up part of the basic rate limit.

Savings income over the PSA

While the Government estimates that 95% of savers will no longer pay tax on their savings income, around 1.4 million people are still expected to have some tax to pay. In most cases, this will be additional rate taxpayers or individuals with higher than average savings.

Savings income exceeding the PSA is taxed at 20% (basic rate taxpayer), 40% (higher rate taxpayer) or 45% (additional rate taxpayer). Where there is tax to pay, HMRC has indicated that it will collect this tax through the PAYE system, on the basis of information supplied by account providers to HMRC.

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