Actual interest rate calculation question

Gemstars2024

Hi all,

I might not be looking at this the right way, however I have quite a high amount in a savings account. I'm a basic rate tax payer so will pay tax on part of the interest if I leave it there this year. 

What I'm wanting to do is work out what percentage of interest I will actually retain after the tax and compare this to the average percentage return on premium bonds to help me decide it it's worth switching over. Does that make sense? 

Secondly, if that is what I do, how do I work out what my limit is to retain in the savings account before paying tax? 

Dazed_and_C0nfused

A lot of that depends on how much basic rate tax you are paying.

If you have earnings or pension and are paying basic rate tax on at least £5,000 of that income then you can just have £1,000 in interest that will be taxed at 0%.

Anything above that will be taxed at 20%.

NB.  The above assumes your interest won't push you into higher rate territory.

masonic

Based on a 50,000 x 1 year Monte Carlo simulation using the projected September draw figures published by NS&I, someone with average luck would get a return equivalent to 3.85% on a full £50k holding. This is equivalent to a savings account paying 4.81% if they pay basic rate tax on all of their interest. So unless you consider yourself lucky, you will probably be better off in taxable savings as a BR taxpayer, even after you start to pay tax on your savings interest.

To estimate out how much in savings you would need to consume all of your PSA, you can divide £1000 by the average interest rate you think you'd be able to achieve over the next year, given this is a moving target. If you take out fixed term accounts, then you will know exactly what interest will be earned and which tax year(s) it will fall within, but for variable rate accounts this could change over the year.

jimjames

Have you used your ISA allowance? If not then moving £20k per year into ISAs will reduce the tax you pay

EthicsGradient

Depending on your plan for your savings in the next tax year, the time at which the interest  will be (or has been) paid on your savings may be important. As masonic says, work out what interest comes from fixed term accounts, and when it has been/will be paid, what interest has already been paid on easy access/notice accounts (eg monthly, or yearly interest you've already had), and then see what, if any, of the £1000 allowance you have left in this year.

If you may use some of the savings in the next tax year (and so receive less interest for it), it might then be worth putting some easy access money now into an account that doesn't pay the interest until next tax year.

Bigwheels1111

How much do you earn.
£12,570 - £17,570 or more.
If you earn say £15,000 you can get £3,570 of interest tax free.
Over £17,570 only £1,000 tax free interest.

Gemstars2024

jimjames said:

Have you used your ISA allowance? If not then moving £20k per year into ISAs will reduce the tax you pay

Yes, that's already used but thank you for the suggestion

Gemstars2024

EthicsGradient said:

what interest has already been paid on easy access/notice accounts (eg monthly, or yearly interest you've already had), and then see what, if any, of the £1000 allowance you have left in this year.

That's a good suggestion, I'll work that out. Thanks. 

zagfles

masonic said:

Based on a 50,000 x 1 year Monte Carlo simulation using the projected September draw figures published by NS&I, someone with average luck would get a return equivalent to 3.85% on a full £50k holding. This is equivalent to a savings account paying 4.81% if they pay basic rate tax on all of their interest. So unless you consider yourself lucky, you will probably be better off in taxable savings as a BR taxpayer, even after you start to pay tax on your savings interest.

That depends what you mean by "average luck", most people think of average as the mean rather than median, the mean "average luck" would get you the published prize fund rate ie 4.4%

The median would depend on how long you hold the PBs. The longer you hold them the closer to the mean the median becomes. But it'd take about 100,000 years for the median to equal the mean   

masonic

zagfles said:

masonic said:

Based on a 50,000 x 1 year Monte Carlo simulation using the projected September draw figures published by NS&I, someone with average luck would get a return equivalent to 3.85% on a full £50k holding. This is equivalent to a savings account paying 4.81% if they pay basic rate tax on all of their interest. So unless you consider yourself lucky, you will probably be better off in taxable savings as a BR taxpayer, even after you start to pay tax on your savings interest.

That depends what you mean by "average luck", most people think of average as the mean rather than median, the mean "average luck" would get you the published prize fund rate ie 4.4%

The median would depend on how long you hold the PBs. The longer you hold them the closer to the mean the median becomes. But it'd take about 100,000 years for the median to equal the mean   

"Average luck" has to have its basis in a ranking, since luck is not intrinsically quantifiable. Premium bond winnings can be considered a function of luck, so someone with average luck would have median winnings. Though I just borrowed the term from the MSE article, which defines it in detail.

The same Monte Carlo simulation can be used to show that even after 100,000 years, the odds aren't very good for converging on the published prize fund rate. The below plot is based on 100,000 simulations of 1 year, which could be strung together to represent a single 100,000 year annual return figure, with the £100k holding representing what a couple could share. Since there is a 1 in 21,000 chance of winning x almost 6 million prizes per draw, it is likely that you won't capture a jackpot prize within the 1.2 million draws that will take place over 100,000 years. The 100k years simulated below did not include a jackpot. A more effective strategy for converging on the official prize rate would be to capture a greater proportion of the ~125bn bonds in the draw I would think. In the extreme, if all PB holders formed a syndicate and shared their winnings, they could all have the published prize rate, but where's the fun in that!

zagfles

masonic said:

zagfles said:

masonic said:

Based on a 50,000 x 1 year Monte Carlo simulation using the projected September draw figures published by NS&I, someone with average luck would get a return equivalent to 3.85% on a full £50k holding. This is equivalent to a savings account paying 4.81% if they pay basic rate tax on all of their interest. So unless you consider yourself lucky, you will probably be better off in taxable savings as a BR taxpayer, even after you start to pay tax on your savings interest.

That depends what you mean by "average luck", most people think of average as the mean rather than median, the mean "average luck" would get you the published prize fund rate ie 4.4%

The median would depend on how long you hold the PBs. The longer you hold them the closer to the mean the median becomes. But it'd take about 100,000 years for the median to equal the mean   

"Average luck" has to have its basis in a ranking, since luck is not intrinsically quantifiable. Premium bond winnings can be considered a function of luck, so someone with average luck would have median winnings. Though I just borrowed the term from the MSE article, which defines it in detail.

The same Monte Carlo simulation can be used to show that even after 100,000 years, the odds aren't very good for converging on the published prize fund rate. The below plot is based on 100,000 simulations of 1 year, which could be strung together to represent a single 100,000 year annual return figure, with the £100k holding representing what a couple could share. Since there is a 1 in 21,000 chance of winning x almost 6 million prizes per draw, it is likely that you won't capture a jackpot prize within the 1.2 million draws that will take place over 100,000 years. The 100k years simulated below did not include a jackpot. A more effective strategy for converging on the official prize rate would be to capture a greater proportion of the ~125bn bonds in the draw I would think. In the extreme, if all PB holders formed a syndicate and shared their winnings, they could all have the published prize rate, but where's the fun in that!

In this context, "luck" is about how much you win, which is absolutely quantifiable. But that's a semantic argument that there's no point getting into, if you disagree so be it. 

But your maths is completely off above. Your PP was based on a full holding, so how do you reckon there's only 1.2 million draws in 100,000 years? There's 50000x12x100000 = 6x10^10 ie 60 billion !!

So based on total PB holding of as you say above of about 125 billion, and 2 £million jackpots per draw, the chances of winning the jackpot per draw is about 1 in 62.5 billion. So in 60 billion draws, someone with average luck (however you define it) would win a jackpot. And the median for wins of the other prizes will be bang on the mean.