Is savings interest included in calculating your tax band?

poppystar

I’m just trying to clarify how savings interest works with relation to tax bands. I understand that as a basic rate payer then there is a £1k allowance on the savings interest and a £500 allowance for the next higher banding. 

So eg if earnings are say £35k and total savings interest is £10k then the income after annual allowance and £9k of the savings interest are both taxed at basic rate. No problem.

What would then happen if income remained the same but savings interest doubled to £20k - does this mean that you become a higher rate tax payer because of the interest taking total money in to over the higher rate threshold and the tax free savings allowance reduces to £500? Or is savings interest income still kept separate and you stay treated as basic rate because that is the band earnings are in? 

Also, just to complicate it what happens if there is also tax free interest from ISAs? I can see it itself remains tax free but is it added to earnings and other savings interest to give total income and the banding done on that? 

Hope that’s clear. Thanks. 

MattMattMattUK

poppystar said:

I’m just trying to clarify how savings interest works with relation to tax bands. I understand that as a basic rate payer then there is a £1k allowance on the savings interest and a £500 allowance for the next higher banding. 

So eg if earnings are say £35k and total savings interest is £10k then the income after annual allowance and £9k of the savings interest are both taxed at basic rate. No problem.

What would then happen if income remained the same but savings interest doubled to £20k - does this mean that you become a higher rate tax payer because of the interest taking total money in to over the higher rate threshold and the tax free savings allowance reduces to £500? Or is savings interest income still kept separate and you stay treated as basic rate because that is the band earnings are in? 

Savings interest contributes to the total taxable income, so in the case of the combined income of £55k then £5k would be taxed at the higher rate.

poppystar said:

Also, just to complicate it what happens if there is also tax free interest from ISAs? I can see it itself remains tax free but is it added to earnings and other savings interest to give total income and the banding done on that? 

Hope that’s clear. Thanks. 

The interest, provided it is paid into the tax free container of the ISA does not count towards income for any taxation purposes. 

Albermarle

Also, just to complicate it what happens if there is also tax free interest from ISAs?

 Any money in an ISA and any interest earned in an ISA, has no impact at all on any tax calculations.

poppystar

Albermarle said:

 Any money in an ISA and any interest earned in an ISA, has no impact at all on any tax calculations.

Does the same apply to other tax free savings interest such as NS&I Index Linked Saving Certs? 

Rodders53

poppystar said:

Does the same apply to other tax free savings interest such as NS&I Index Linked Saving Certs? 

The clue is in the phrase tax free... and to quote from https://www.nsandi.com/files/asset/pdf/index-linked-savings-certificates-summary.pdf

Tax-free means the interest is exempt from UK Income Tax and Capital Gains Tax

ain't Google wonderful? 

poppystar

Rodders53 said:

poppystar said:

Does the same apply to other tax free savings interest such as NS&I Index Linked Saving Certs? 

The clue is in the phrase tax free... and to quote from https://www.nsandi.com/files/asset/pdf/index-linked-savings-certificates-summary.pdf

Tax-free means the interest is exempt from UK Income Tax and Capital Gains Tax

ain't Google wonderful? 

I understood the tax free bit honest - even without mr Google! 😉. 

I was likening it to our personal tax free allowance - that is free of tax but that counts towards the total income surely? Ditto interest on taxable savings is, as above replies indicate, added to other income to calculate tax banding and from there what allowance will then be applicable to the savings interest. Hence the tax bands.  It seemed possible that while exempt from tax itself, the tax free interest could be added to income for calculating which tax band you are in for the paying of tax on those parts of income that are taxable.

I am pleased by your assurance it doesn’t though! 

eskbanker

poppystar said:

I was likening it to our personal tax free allowance - that is free of tax but that counts towards the total income surely? Ditto interest on taxable savings is, as above replies indicate, added to other income to calculate tax banding and from there what allowance will then be applicable to the savings interest. Hence the tax bands.  It seemed possible that while exempt from tax itself, the tax free interest could be added to income for calculating which tax band you are in for the paying of tax on those parts of income that are taxable.

Best to think of two entirely separate streams - taxable income and non-taxable income.

Non-taxable income includes that from ISAs and accounts correctly described as tax-free, such as those NS&I ones.

Taxable income includes salaries, pensions, and interest earned from savings accounts (excluding the above).  This income is measured against the personal tax allowance but that doesn't make this allowance 'tax-free' as such, even though no tax is payable on income that falls within it....

poppystar

Ok, it’s clearer but that leaves the question of at which point the savings interest allowance is counted.

eg. Income £35k savings interest £16k, higher rate threshold £50271. 

If savings allowance of £1k taken off first then total is £50k - still basic rate tax payer on this.

If all savings interest added to income then total is £51k - over the higher tax threshold.
which means allowance only £500 leaving £50500 and £229 taxed at higher rate. 

Which is the correct method? 

Dazed_and_C0nfused

poppystar said:

Ok, it’s clearer but that leaves the question of at which point the savings interest allowance is counted.

eg. Income £35k savings interest £16k, higher rate threshold £50271. 

If savings allowance of £1k taken off first then total is £50k - still basic rate tax payer on this.

If all savings interest added to income then total is £51k - over the higher tax threshold.
which means allowance only £500 leaving £50500 and £229 taxed at higher rate. 

Which is the correct method? 

You ignore the savings nil rate band (aka PSA) when determining what the savings nil rate band should be.

So on the basic facts of taxable income of £51,000 (£35k + £16k) the person would be deemed a higher rate payer and get a savings nil rate band of £500.

EthicsGradient

On the face of it, this means there can be a nasty "corner" you can get trapped in, where a small extra amount of interest means £100 or so extra tax to pay.

The threshold for whether the "personal savings allowance" is £500 or £1,000 is if your total income is above the personal allowance £12,570 + basic rate band £37,700 = £50,270

If earned income is £35k, and interest £15,269, then the nil rate band is £1,000, and tax paid is 20% on (50269-12570-1000)=£7,339.80 (or: 0.2*(35000-12570) + 0.2*(15269-1000))

If earned income is £35k, and interest £15,271, the nil rate band is £500. Tax paid on earned income still = 0.2*(35000-12570). Now, 15271-500=£14,771 of savings is  taxed at 20%, ie £2,954.20, bringing the total tax to £7,440.20.

So £2 extra savings interest has increased the tax bill by £100.40. 

I have a vague feeling I saw something once said they somehow managed to calculate this so there wasn't a sudden jump in tax at this point - but that may have been wishful thinking, and I can find it now. 

poppystar

Yes, it was wondering if there was such a ‘nasty corner’ that prompted me to get clarification on how the calculation is done.