Taxation of savings – what can you have tax-free?

Knowledge base from Boox

By Lynne Gowers on 19th January 2018

Taxation of savings – what can you have tax-free?

There is no one answer to the amount of savings income and, for 2017/18, the answer can range from £0 to £18,650, depending on personal circumstance

When looking at tax-free savings, there are a number of elements to take into account:

• the personal allowance;
• the marriage allowance;
• the savings allowance; and
• the starting rate for savings.

Savings income, such as bank and building society interest, is now paid gross without tax deducted.

Personal allowance

If a person has no other income (or only dividend income in addition to savings income), or their other income is less than £11,500, some or all of the personal allowance (set at £11,500 for 2017/18) will be available to shelter savings income.

Marriage allowance

Where the marriage allowance is claimed, this increases the potential tax-free income by £1,150 in 2017/18.

Savings allowance

In addition to the personal allowance, individuals who pay tax at the basic or higher rate are also entitled to a savings allowance. The amount of the allowance depends on the individual’s marginal rate of tax and is set at £1,000 a year for basic rate taxpayers and at £500 a year for higher rate taxpayers. There is no savings allowance for additional rate taxpayers.

Savings starting rate

Savers with little in the way of other taxable income can also benefit from a 0% savings starting rate on savings of up to £5,000, in addition to savings sheltered by the personal and savings allowance. However, the savings starting rate is quite complicated in that the starting rate limit is reduced by taxable non-savings income. So, if a person has taxable non-savings income of £2,000, the savings starting rate of 0% is available on savings income of £3,000, as the £5,000 limit is reduced by the taxable non-savings income of £2,000 to £3,000. Likewise, if a person has taxable non-savings income of more than £5,000, the savings starting rate limit is reduced to nil.

Case study 1: maximum tax-free savings

Elsie is retired and her only income is savings income, which in 2017/18 is £20,000. Her husband has income of £8,000 and Elsie benefits from the marriage allowance of £1,150. The first £11,500 of her savings income is covered by her personal allowance of £11,500 and the next £1,150 by the marriage allowance, leaving £7,350, of which £1,000 is covered by the personal savings allowance for basic rate taxpayers. This leaves savings income of £6,350. As she has no taxable non-savings income, she is entitled to the savings starting rate of 0% on savings equal to the saving starting rate limit of £5,000. Consequently, she is able to enjoy £18,650 (£11,500 + £1,150 + £1,000 + £5,000) of her savings tax-free and is taxed at the basic rate of 20% on her remaining savings of £1,350 – giving her a tax bill of £270.

Case study 2: reduced starting rate limit

In 2017/18, Arthur has a pension of £14,000 and savings income of £6,000.
His personal allowance is set against his pension, leaving him with taxable non-savings income of £2,500.
He is entitled to the saving personal allowance of £1,000, which is set against £1,000 of his savings income.
As he has taxable non-savings income of less than £5,000, the savings starting rate is reduced by his taxable non-savings income of £2,500 to £2,500. £2,500 of his savings income is eligible for the 0% savings starting rate.
He, therefore, receives savings income of £3,500 tax-free. The remaining £2,500 of his savings income is taxed at 20%, as is the excess of his pension over his personal allowance of £2,500. His tax bill for £2017/18 is, therefore, £1,000 (£5,000 @ 20%).

Case study 3: higher rate taxpayer

Wendy has a salary of £50,000 and savings income of £5,000 in 2017/18. Her personal allowance is set against her salary. She is entitled to the personal savings allowance of £500 available to higher rate taxpayers, but she is not eligible for the savings starting rate as her taxable non-savings income (£38,500, being £50,000 – £11,500) is more than £5,000. She receives tax-free savings income of £500.
As the case studies show, the amount of savings income a person may receive can vary considerably depending on what other income they have and the rate at which they pay tax.

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