You may already be aware of the personal savings allowance. This offers an allowance of £1,000 of interest income for basic rate taxpayers, or £500 for higher rate taxpayers. (The allowance is not available to additional rate taxpayers.) Additionally, if you are a low-income earner, you may be eligible to earn up to £5,000 of interest from savings at 0% tax rate. This is called the starting rate for savings.
Let’s look at some different scenarios to illustrate how the savings starting rate works at various income levels.
Your non-interest income is less than the personal allowance
For the 2019/20 tax year, if your other income is less than the £12,500 personal allowance, you can earn up to £6,000 of interest income (£1,000 interest allowance plus £5,000 savings starting rate) and pay no tax.
Example 1 – You are retired, and your incomes are:
- £9,000 state pension
- £3,000 dividend
- £6,000 interest
Your non-interest income is £9,000 + £3,000 = £12,000. This is less than the £12,500 personal allowance and therefore would incur no tax liability. In addition, you will be eligible to earn the full £6,000 interest income tax free. Your total tax liability for the year is £nil.
Your other income is more than the personal allowance but less than the combination of personal allowance and savings starting rate
Example 2 – You are retired, and in addition to the state pension, you also decide to take advantage of the pension drawdown:
- £9,000 state pension
- £4,000 pension drawdown
- £3,000 dividend
- £6,000 interest
Your non-interest income is £9,000 + £4,000 + £3,000 = £16,000. This is £3,500 over £12,500, so you will lose £3,500 of the £5,000 savings starting rate (leaving a £1,500 allowance). Of course, you will incur some tax liability on the income above the personal allowance. In this example you will be able to utilise your £2,000 dividend allowance. Based on all these factors your tax liability will be:
- £9,000 + £4,000 = £13,000 – £12,500 personal allowance = £500 @ 20% tax = £100
- £3,000 – £2,000 dividend allowance = £1,000 @ 7.5% tax = £75
- £6,000 – £1,000 interest allowance – £1,500 savings starting rate = £3,500 @ 20% tax = £700
- Total tax = £100 + £75 + £700 = £875
Your other income is more than the combination of personal allowance and savings starting rate
Example 3 – You are retired, and in addition to state pension you earn income from dividends and from a rental property you own:
- £9,000 state pension
- £7,000 property rental income
- £3,000 dividend
- £6,000 interest
Your non-interest income is £9,000 + £7,000 + £3,000 = £19,000. This exceeds £12,500 by £6,500. Therefore, you will lose all the £5,000 savings starting rate allowance, but you will retain the £1,000 interest allowance. In this case, your tax liability will be:
- £9,000 + £7,000 = £16,000 – £12,500 personal allowance = £3,500 @ 20% tax = £700
- £3,000 – £2,000 dividend allowance = £1,000 @ 7.5% tax = £75
- £6,000 – £1,000 interest allowance = £5,000 @ 20% tax = £1,000
- Total tax = £700 + £75 + £1,000 = £1,775
It can be seen in this scenario that the total benefit of the savings allowances amounts to only £200. I.e. instead of the full £6,000 being taxed at 20% to generate a tax liability of £1,000, the tax liability on interest is reduced to £1,000.
One final observation is that, while the £5,000 saving starting rate does seem generous, in the current environment of ultra-low interest rates many will struggle to generate enough savings to take full advantage of the allowance. Therefore, it will be of limited use.