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Tax on savings and investments – how it works

Whether you're putting something away for a rainy day, investing for retirement or anything in between, there are likely to be tax savings and allowances you can benefit from. There may also be some pitfalls to look out for. This guide will help you get to grips with how tax on savings interest is calculated, how the personal savings allowance works and whether your investments could be subject to tax.

The starting rate for savings if you’re on a low income

The starting rate for savings is aimed at supporting savers on the lowest incomes.

For 2021/22 it is £5,000. This means that up to £5,000 of the interest received from savings is tax-free.

You can earn up to £17,570 a year in 2021-22 (as long as your personal allowance is the standard £12,570) and usually still be eligible for the starting rate for savings.

This upper income limit is higher if you’re claiming the Blind Person’s Allowance (increasing the amount you can earn by £2,520 for the Tax Year 2021/22 to £20,090) or the Marriage or Married Couple’s Allowance (which gives an amount that’s dependent on your personal circumstances).

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The starting rate for savings is reduced by £1 for every £1 you earn over the Personal Allowance. The Personal Allowance is the amount you can earn tax-free from non-savings income like a job or pension and is currently £12,570.

For example, someone with a salary of £14,570 per year and interest on savings of £150:

Income
Personal Allowance
Amount earned over the Personal Allowance
Remaining amount for savings interest that can be tax free

£14,570

£12,570

£14,570-£12,570 = £2,000

£5,000-£2,000 = £3,000

That means that £3,000 can be earned in interest from savings tax free, so the £150 of interest they have earnt from their savings will be tax free.

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The Personal Savings Allowance

As well as the starting rate for savings, there is also a Personal Savings Allowance.

Like with the starting rate for savings, the Personal Savings Allowance lets you earn a certain amount of interest from your savings tax free.

Depending on the Income Tax band your income falls under, the Personal Savings Allowance is a different amount:

Basic rate taxpayer – £1,000

Higher rate taxpayer – £500

Additional rate taxpayer – £0

How much tax you’ll pay on savings?

Although the interest you get on your savings, like any other income you receive, is normally taxable any savings interest from your bank or building society is usually paid ‘gross’. Here are the limits for the amount of interest you can earn tax-free.

Your Rate of tax
Income, such as salary, not from savings
Amount of interest on savings that’s tax free

No tax

£0 to £12,570

Can earn a maximum of £5,000 in interest from savings tax-free with the starting rate for savings. See the starting rate for savings section, above, for more details.

Basic rate taxpayer – low income

£12,571 to £17,570

Can earn up to £5,000 in interest tax-free with the starting-rate for savings. Can also earn up to £1,000 of further interest on their savings without having to pay tax with the Personal Savings Allowance.

Basic rate taxpayer

£17,571 to £50,270

Can earn £1,000 interest on their savings without having to pay tax with the Personal Savings Allowance.

Higher rate taxpayer

£50,271 to £150,000

Can earn up to £500 worth of interest tax-free with the Personal Savings Allowance.

Additional rate taxpayer

Over £150,000

No savings interest allowance.

Any interest from savings that is over your Personal Savings Allowance or Starting Rate for Savings is taxed. The amount of tax depends on your income.

The Personal Savings Allowance and starting rate for savings covers interest from:

  • bank and building societies
  • savings and credit union accounts
  • open-ended investment companies (OEICs), investment trusts and unit trusts
  • peer-to-peer lending
  • government or company bonds
  • life annuity payments
  • some life insurance contracts.

If you live in Scotland, the tax income thresholds and rates are slightly different. But, you’ll still pay the UK rates of income tax on taxable savings income such as bank interest and dividend income.

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Claiming back tax

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Tax-free savings

Some savings products pay interest that is always tax-free, regardless of how much you earn or other savings interest you are receiving. Most savers no longer need to save into an ISA to earn some interest tax free, thanks to the introduction of the Personal Savings Allowance.

Your ISA allowance for the 2021/22 tax year is £20,000, meaning you can still save tax free even if you are an additional rate taxpayer.

Tax-free savings products include ISAs and some NS&I products 

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Share-based investments

If you own shares, you may get income in the form of dividends.

Dividends are a portion of the profits made by the company that issued the shares you’ve invested in.

If you have an investment fund that is invested in shares, then you may get distributions that are taxed in the same way as dividends.

For the tax year 2021/22 the tax-free Dividend Allowance is £2,000 a year.

Dividends above this level are taxed at:

  • 7.5% (for basic rate taxpayers)
  • 32.5% (for higher rate taxpayers)
  • 38.1% (for additional rate taxpayers).

Any dividends received within a pension or ISA are unaffected and remain tax-free.

Basic rate payers who receive dividends of more than £2,000 need to complete a self-assessment return.

For example:

  • If you receive dividend income of up to £2,000 outside an ISA, you’ll pay no tax on your dividends, even if you’re a higher or additional rate taxpayer.
  • If your total income is less than £12,570 (the current personal allowance), any income is covered by your personal allowance. You’ll have no tax to pay as your dividend allowance of £2,000 is untouched.
  • If your dividend income is received within an ISA, it will remain tax-free and the dividend allowance will not impact any income you receive.
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Tax-efficient investments

Stocks and shares ISAs are tax-efficient investments because all capital gains, interest, and dividend income is completely tax-free. It’s important to know that you’ll pay investment charges on stocks and shares ISAs, just like any other investments.  

Where the investments in your stocks and shares ISA do not pay dividends, but instead pay interest (for example, government and corporate bonds), the interest paid remains tax-free.

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Saving into a pension can be another tax-efficient way of investing. 

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Other options

It might make sense to consider other types of investment funds, such as Unit Trusts and Open-Ended Investment Companies (OEICS).

With these funds, part of the proceeds you receive count as income and are typically taxed, while part may come from gains due to rising share prices.

If you have a capital gains tax-free allowance limit (currently £12,300 for the tax year 2021-22), you might find yourself paying less tax if you hold these types of investment fund rather than some life-insurance investments.

With any type of investment, where there is a risk you could lose your money, consider taking regulated financial advice to help you choose which type of investment is right for you. You might have to pay for the advice, but it could save you a lot of money (and worry) in the long run.

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MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

Continue to website
Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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