While the relentless increase to interest rates over the past 18 months has posed challenges to businesses and households, as the cost of borrowing has inexorably risen, there has been a silver lining for savers. Rates on savings returns are finally rising after years in the doldrums.
However, savings rates still lag behind inflation so savings are losing value in real terms, while increased returns mean that many individuals may face a tax bill. Here, we look at the challenges facing savers as interest rates increase.
Frozen Savings Allowance
The frozen Savings Allowance, combined with rising interest rates, will push over one million individuals into paying tax on their savings this tax year, according to research by investment platform AJ Bell.
In the 2023/24 tax year it is estimated that over 2.7 million individuals will pay tax on interest, up by a million in a year.
This year's predicted total includes nearly 1.4 million basic rate taxpayers, a figure which has quadrupled in just four years, AJ Bell's research found.
Tax on savings income
Savings income is income such as bank and building society interest.
The Savings Allowance applies to savings income and the available allowance in a tax year depends on the individual's marginal rate of income tax. Broadly, individuals taxed at up to the basic rate of tax have an allowance of £1,000. For higher rate taxpayers the allowance is £500. No allowance is due to additional rate taxpayers.
Savings income within the allowance still counts towards an individual's basic or higher rate band and so may affect the rate of tax paid on savings above the Savings Allowance.
Some individuals qualify for a 0% starting rate of tax on savings income up to £5,000. However, the rate is not available if taxable non-savings income (broadly earnings, pensions, trading profits and property income, less allocated allowances and reliefs) exceeds £5,000.
Tax bills from savings income are paid either through self assessment or deducted from income through a tax code adjustment. Many won't be aware that they owe the tax until HMRC sends them a letter to change their tax code to deduct the money from their payslip.
That tax hit will compound the fact that cash savings are losing value in real terms, with savings interest lagging well behind the rate of inflation.
Tax-efficient savings strategies
It is vital to review your financial strategies regularly. This includes planning to make the most of the tax-saving opportunities available to you, particularly ahead of the tax year end in April.
Individual Savings Accounts (ISAs)
ISAs are sometimes referred to as a tax 'wrapper' for investments: they allow you to make a tax-efficient investment, rather than dealing directly in the investment market and facing the tax consequences attaching.
The tax benefits here are considerable. ISAs are free of income tax and capital gains tax and do not impact the availability of the savings or Dividend Allowance.
There are four types of ISA: cash ISAs, stocks and shares ISAs, innovative finance ISAs and Lifetime ISAs. The total you can invest in any tax year is set by the government: for the tax year 2022/23, it is £20,000. This can be allocated across the different types, as you choose.
Although you cannot hold an ISA with, or on behalf of, someone else, you and your spouse each have an ISA subscription limit: this means you can invest £40,000 between you.
Premium bonds from NS&I offer a secure way to hold cash. Rather than a set interest rate, prizes of £25 to £1 million are paid monthly. The advantage is that any prizes are free of tax. However, the return on Premium Bonds is not guaranteed and you may never win a prize, so anyone choosing this option needs to be prepared to make no return on their money.
Using your partner's allowance
Every individual is entitled to their own personal allowance (PA), which is £12,570 for the 2022/23 tax year. A key element in tax planning is to make the best use of the PA. If your spouse or civil partner has little or no income, you might want to consider the ownership of income-producing assets.
This may involve redistributing income-producing assets to minimise the couple's tax liability – but be mindful of the settlements legislation governing 'income shifting'. Any transfer must be an outright gift, with 'no strings attached'.
Use your pension
If you've just tipped over into the next tax bracket, and seen your Personal Savings Allowance halved or wiped out you can use your pension to bring you back down into the lower income tax bracket. When you contribute to your 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.
As your accountants, we can work with you to make sure your business and personal finances are in the strongest possible position for whatever the future may hold. Please get in touch to discuss the tax planning opportunities available to you.