The Personal Savings Allowance (PSA) determines how much savings account interest is taxable.
Until April 6, 2016, savings interest was taxed at the same rate as income.
Banks usually paid net interest, having deducted tax before handing it over to savers. That all changed with the introduction of the Personal Savings Allowance.
How the Personal Savings Allowance works
Like the personal allowance for income tax, the PSA lets savers receive gross interest on their savings without paying tax up to a certain threshold.
The amount depends on which income tax bracket you fall into.
Personal Savings Allowance Thresholds for 2017-2018
|Tax band||Total income||Personal Savings Allowance|
|Basic rate||Up to £45,000 (£46,350 a year 2018/2019)||up to £1,000 of interest is tax-free|
|Higher rate||£45,000 to £150,000 a year (Raises to 46,350 in 2018/2019||up to £500 of interest is tax-free|
|Additional rate||More than £150,000 a year||£0 – all interest is taxed|
For the vast majority of people, this is good news.
The Treasury estimates that around 95% of savers will not have to pay any tax on their savings.
What happens if I go over the Personal Savings Allowance?
With interest rates at historic lows, most savers need a significant level of savings to earn enough interest to go over the PSA basic rate threshold.
If they do, then the additional savings interest is taxable and considered as part of their overall income.
Calculating Your Personal Savings Allowance
In order for a basic rate taxpayer to earn more than £1,000 interest at a rate of 1.82%, which is achievable for some fixed rate, long-term savings accounts, they would need to have a constant level of at least £54,945 in a savings account.
For a basic rate taxpayer with savings above that level, their additional savings interest would be taxable. So someone with £100,000 in a savings account earning 1.82% a year, with a salary of £30,000 a year, would earn a total of £1,820 in interest.
The first £1,000 is tax-free, so the total income would be assessed at £30,820.
What if I am a Higher Rate Taxpayer?
The same principle applies to higher rate taxpayers, but the threshold is lower at £500.
So a higher rate taxpayer could keep £27,472.52 in a 1.82% savings account without needing to declare any additional interest as income.
Many people who do earn interest that takes them over the threshold will not have to do anything – the Treasury says that HMRC will simply collect the tax owed by changing your PAYE tax code.
Which Investments Apply to the Personal Savings Allowance?’
Savings income is considered by HMRC to be account interest from banks, building societies and credit unions.
It covers interest from authorised unit trusts, open-ended investment companies and investment trusts (but not dividend payments), income from government or company bonds, and most types of purchased life annuity payments.
Which Investments don’t Count Towards Your Personal Savings Allowance?
Savings vehicles which are already considered to be tax-free do not add to your PSA. So any investment with an Individual Savings Account (ISA) wrapper does not add to your PSA.
Likewise, interest from National Savings and Investments (NS&I) tax-free products, including premium bonds, are also considered to be tax-free.
Is the Personal Savings Allowance the Same for Pensioners?
There is no difference for pensioners, which means that pensioners who previously could receive pensions interest tax-free through the R85 form are no longer able to do so.
For bonds or other products where interest is not paid annually but is paid in a lump sum at the end of the investment, interest which has accrued – but has not been received – does count towards your PSA.
In other words, if you have a three-year bond which pays out a lump sum at the end, you would need to count the interest accrued each year towards your PSA.