The rise in availability of savings schemes such as ISAs and Premium Bonds has meant that many people now save money totally tax-free. However, the majority of savings accounts, as well as regular bank accounts that are in credit, are normally subject to a 20% or 40% tax, depending on which tax bracket you fall into.
If you are a basic rate (20%) taxpayer and you have a bank or building society account, tax will have been deducted at a rate of 20% before you even receive your interest; this is why the interest credited to your account will appear as 'net interest' on your bank statement. In almost all circumstances, your savings will be taxed in this way, and it is then your responsibility to either reclaim over-paid tax or pay tax that you still owe.
Tax Rates
In the first instance, it is important to note that savings income is added to your other income for tax purposes. Most taxpayers receive a Personal Savings Allowance (PSA) - £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Interest within this allowance is tax-free. The starting rate for savings provides 0% tax on up to £5,000 of savings income if your non-savings income is below £17,570. This affects very few people, as income and savings exceeds this threshold for the vast majority of tax-paying individuals. If your total income exceeds £50,270, you become a higher rate taxpayer and pay 40% tax on income above this threshold. If that income exceeds £150,000, you will pay tax at 50%.
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It may come as no surprise to hear that reclaiming over-paid tax is generally a longer process than paying tax that is owed. Since April 2016, banks pay interest gross so form R85 is no longer needed for most savers. If you've overpaid tax on savings interest, you can reclaim it using form R40.
Paying Outstanding Tax
Making payments for tax that is due can represent some extra work, but it is generally the case that your payment will be taken more quickly than payments will be made to those who are owed refunds. Basic rate taxpayers don't need to pay additional tax on savings interest that falls within their £1,000 Personal Savings Allowance. Any interest above this allowance is taxed at 20% and is usually collected through PAYE code adjustments. However, if you are a higher rate taxpayer, it is your responsibility to inform your Tax Office of how much interest you have received. Again, the way in which you do this will depend on your circumstances.
If you are a self-assessment taxpayer, the process is simple; you just need to declare your savings interest on your tax return, and HM Revenue & Customs (HMRC) will calculate accordingly. Similarly, if you completed a Self-Assessment form during the previous tax year but now pay tax through PAYE, your outstanding tax will be automatically deducted from your wage packet via PAYE.
If, on the other hand, you do not normally pay tax via self-assessment, but you have recently shifted into the higher tax bracket, it is your responsibility to contact your Tax Office to let them know how much interest you have received. It is likely that you will then be asked to complete a return, unless you are an employee or paying a pension, in which case your outstanding tax may be collected via PAYE.
Finally, if you are no longer required to complete a tax return, it is likely that you will receive a copy of form P810 (the Tax Review Form). This will require you to give some information about your current savings levels in order that HMRC can make the relevant calculations.
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