I’m a money expert – four ways to avoid surprise tax on your savings

MILLIONS of people are being hit by a surprise tax on their savings, but there are ways to avoid it and keep more of your cash.

Anyone with a bank account where they earn interest on their savings could be hit with an unexpected tax bill.

That’s because rising interest rates mean more people are making money from the cash they’ve stashed away.

But make over a certain amount and you’ll have to pay tax on it.

Laura Suter, head of personal finance at AJ Bell, said: “Almost 2million people were hit with a tax on their savings this year and paid £3.4billion to the Government in tax.

“That’s because interest rates have risen and more people are breaching their tax-free savings limits – often for the first time.

“The personal savings allowance currently stands at £1,000 and £500 for basic rate and higher rate taxpayers respectively.”

Additional rate taxpayers get no tax break, meaning those with income of more than £125,140 now pay 45% tax on any cash interest outside an ISA.

Laura added: “When the base rate was 0.1%, if your savings were earning that amount of interest, a basic-rate taxpayer would need to have £1million in cash savings to hit their £1,000 tax-free limit.

“However, fast forward to today and with the top easy-access savings account now paying 4.5% that same basic-rate taxpayer would only need to have around £22,000 in savings to hit the limit.

“What’s more, if that basic-rate taxpayer had seen their income rise in the past few years and had moved into the higher-rate income tax bracket, they would only have a £500 tax-free savings limit, meaning they would only need to have around £11,000 in savings before they hit their new, lower limit.”

But anyone who thinks they will be caught in this tax trap can avoid paying the tax – perfectly legally. We explain below.

ISAs

“ISAs are your best defence against paying tax on your savings”, Laura said.

This is because any money in an ISA is protected from tax, meaning that the interest you earn won’t count towards your Personal Savings Allowance.

Laura said: “If you’ve already breached your Personal Savings Allowance then accepting a lower interest rate on an ISA account might make more financial sense, particularly for higher and additional rate taxpayers who will be paying 40% and 45% tax on their savings respectively.

“Each individual can put up to £20,000 into an ISA each year, they just need to check they haven’t made any contributions so far this year into any other ISAs.”

Give money to your partner

If you have maxed out your Personal Savings Allowance but your partner hasn’t, you could move some savings to them to avoid paying tax.

Laura says it’s best to work out how much you’d need in savings to bring you under your tax-free limit and move the rest to your partner.

She added: “Any transfers of money between spouses aren’t subject to tax, so you don’t need to worry about telling the taxman.

“But you will need to be comfortable with sharing money with your partner.

“If your partner has reached their Personal Savings Allowance but hasn’t used their ISA allowance this year it could still make sense to move the savings to them.”

You could also transfer money to them that they then pay into their ISA, to protect it from tax this year and in the future.

Move money to a lower-earning spouse

Even if both you and your partner have breached your tax-free limits, you could still benefit from transferring cash to them if they pay a lower rate of income tax than you.

For example, if you’re a higher-rate taxpayer you’ll pay 40% tax on any savings interest over your Personal Savings Allowance but if your partner is a basic-rate taxpayer they will only pay 20% tax on it.

Laura said: “If you’re earning £500 a year in savings interest over your tax-free limit, a higher-rate taxpayer would pay £200 in tax on that while a basic-rate taxpayer would only pay £100 – meaning a potential saving of £100.

“The higher your savings income the greater the potential tax saving.”

If your partner doesn’t earn any money they can get up to £18,570 in savings interest in a year before they have to pay tax on it.

That’s because their savings interest counts towards their Personal Allowance and they could also benefit from the Starting Rate for Savings, which gives an additional £5,000 of tax-free savings income.

On top of that, they’d still benefit from the Personal Savings Allowance.

Laura added: “Based on the current top easy-access rate of 4.5% you’d need to have £410,000 saved to breach that generous savings limit – enough for the vast majority of people.”

Use your pension

Lots of people are being caught out where they have just tipped over into the next income tax bracket.

This hits you with a double whammy of seeing your Personal Savings Allowance cut in half or disappear altogether, while also meaning you pay a higher rate of tax on your savings income.

For example, someone who has £1,000 of savings interest and is a basic-rate taxpayer won’t pay any tax on their savings interest because it’s within the Personal Savings Allowance.

But if they get a pay rise that tips them into the higher-rate tax bracket, they will lose half that savings limit, down to £500.

On top of that, they will have to pay 40% tax on their savings income, landing them with a £200 tax bill.

Laura said: “One way to bring yourself back into the lower tax band is to make pension contributions. 

“When you contribute to your self-invested personal pension (SIPP), the gross value of the contribution has the effect of extending your basic rate tax band, meaning that you could avoid tipping into the higher-rate band.

“Clearly you need to be able to afford to sacrifice the income in order to make the pension contribution, but this is a particularly handy trick if you’ve only just gone into the next tax band, meaning a small pension contribution would bring you under the threshold.”

Meanwhile, thousands of savers are owed £3,551 each as HMRC overcharges on tax – check if you’re affected.

Plus, households are being hit with soaring tax bills after rates continue to rocket – how to avoid it.

Do you have a money problem that needs sorting? Get in touch by emailing money-sm@news.co.uk.

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