Interactive Investor

Tax-free savings are changing: what you need to know about the personal savings allowance

29th March 2016 11:48

Ruth Jackson from interactive investor


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The new tax year will bring some big changes to how your savings are taxed. From 6 April 2016, most people will no longer have to pay tax on the interest earned on money held in their bank or building society accounts.

This could have a huge effect on how you save and raises questions about whether individual savings accounts (Isas) are still worth bothering with.

  • Budget 2016: Tax rates round-up.


What is the personal savings allowance?

From 6 April 2016, most of us will be given a personal savings allowance, which is an amount of interest we can earn on all our non-Isa cash deposits before income tax is due.

If you are a basic-rate income taxpayer, you can earn up to £1,000 in interest in a tax year before income tax needs to be paid. For higher-rate taxpayers, the allowance drops to £500 a year, but if you are an additional-rate taxpayer earning more

than £150,000 a year, you won’t get a personal savings allowance at all.

“The new personal savings allowance will be good news for most people, reducing tax for many and eliminating the need for low income individuals to claim a repayment for tax deducted from interest,” says ZoeRoberts, a partner at chartered accountant BHP.

What accounts does it apply to?

The new allowance covers interest earned from bank accounts, building society accounts, credit unions, corporate bonds, government bonds, gilts, and peer-to- peer lending.

The allowance will also apply to interest distributions from investment funds, investment trusts and most purchased life annuity payments.

But it does not cover dividends – a form of income that some companies pay out of their annual earnings to their shareholders. However, a new dividend tax allowance is also being introduced in April 2016. This will allow everyone to earn up to £5,000 in dividends tax-free each year.

The allowance doesn’t apply to interest earned in Isas or money won from Premium Bonds. These payments will still be tax-free and they will not count towards your annual personal savings allowance.

How do I claim my allowance?

You don’t need to do anything. From 6 April, banks and other firms that pay you qualifying interest will simply stop deducting income tax.

If tax is owed on your savings’ interest, HMRC says it will be taken via your tax code, so out of your wages.

If HMRC believes you will earn more savings interest than the savings allowance covers, your personal allowance – how much you can earn before income tax is due – will be lowered to reflect that interest. This will mean you’ll be given a different tax code.

The standard tax code is 1100L. If yours is different and you don’t know why, speak to HMRC (0300 200 3300) to check you aren’t paying more tax than you need to.

If you are self-employed, your savings’ interest will need to be declared on your self-assessment forms and tax paid accordingly.

Should I abandon my Isas?

If all your savings will earn interest tax-free anyway, it can seem as if Isas have become pointless. That isn’t the case.

“There are quirks and anomalies in the system that give Isas some hidden benefits,” says Danny Cox, a chartered financial planner at Hargreaves Lansdown.

The main benefit of an Isa is that the interest earned is tax free no matter how much the Isa grows. If you had fully invested in Isas every year since they started in 1999, you would have sheltered £163,320 from the taxman.

You could not protect that much money from tax simply by relying on your personal savings allowance.

If interest rates rise, you could find yourself paying tax on your savings income once you start earning more than the allowance. That doesn’t happen with money held in an Isa.

Ms Roberts adds: “As people’s incomes can fluctuate from year to year, investing in Isas may still have a benefit as it guarantees tax- free income rather than relying on a savings allowance, which may fluctuate between £1,000, £500 or nil each year.”

If you use your Isa to invest in the stock market, your gains will also be protected from capital gains tax (CGT). Abandon your Isa, and you will be liable for tax if your gains exceed the annual CGT allowance of £11,100.

Finally, interest earned on Isas doesn’t count towards your personal savings allowance. This means if you are approaching your personal savings allowance limit, move money into an Isa to avoid starting to pay income tax on it.


Make the most of both Isas and savings

Isas offer you long-term peace of mind that your money is safe from the taxman. But at the moment you can get better interest rates outside of the Isa wrapper.

The arrival of the personal savings allowance means you can take advantage of both. Build up your savings in a standard savings account paying the best interest rates – look at current accounts offered by Santander, TSB and Nationwide for the best rates.

Then if you’ve built up a sizeable savings pot, move some or all of it into an Isa to make sure it is free from tax long-term and the interest earned doesn’t affect your personal savings allowance.

First-time buyers stick to Isas

First-time buyers should be making the most of Help to Buy Isas before they consider using their personal savings allowance.

These special Isas come with good interest rates and the promise of a 25% government bonus when you are ready to buy your first home. This means you’ll get a much better return than a standard savings account – even if the interest rate is higher on the standard account.

However, the most you can save into a Help to Buy Isa is £200 a month (with an initial deposit of £1,000). If you want to save more than that, then the personal savings allowance means you can get a tax-free return on a standard regular savings account so you can save tax-efficiently in both.

  • Compare Isa rates with our Isa comparison tool.


How much money can I save before I max out the allowance?

The amount you can save depends on whether you pay basic- or higher- rate income tax. Be aware that the interest you earn could push you into a higher income tax bracket and therefore cut how much tax-free interest you can earn.

Here’s a table to show you how much you can save tax free, assuming you have no other savings:

Best accounts Basic-rate taxpayer Higher-rate taxpayer
Easy access - ICICI Bank 1.4% £71,420 £35,710
Top two-year fix - Paragon 2% £50,000 £25,000
Top five-year fix - 2.8% from Shawbrook Bank £35,715 £17,857


This article was originally published in our sister magazine Moneywise, which ceased publication in August 2020.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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