Does bank interest gets added to your income which dictates your tax bracket and PA?

Spir4

Hi everyone,

Are these scenarios correct or not:

Scenario 1:
Your income from employment is £100,000, and you've received £500 interest from saving accounts. You're not paying tax on the £500 interest because that's still within the PSA for a higher rate earner. However, the £500 is also seen as income, so your total income is now £100,500 (there is no other income), which means you've lost £250 from your tax-free PA.

Scenario 2:
Your income from employment is £50,270, and you've received £1000 interest from saving accounts. This makes your total income £51,270, which puts you in the higher rate earner tax bracket. This means your PSA has gone down to £500, and because you're now in the higher rate tax bracket you pay 40% tax on the extra £500.

My question basically boils down to this: does the interest you earn on saving accounts (be it tax free or not) adds to your income and can push you into a higher tax bracket and even reduce your Personal Allowance?

Thanks!

Dazed_and_C0nfused

Assuming you are referring to taxable interest, not interest from an ISA then,

1.  Yes.

2.  Yes. 

But pension contributions are an easy way to avoid this.

If the interest is tax free (from an ISA) then you wouldn't count it.

It can also reduce the amount of Married Couple's Allowance due and increase a High Income Child Benefit Charge.

eskbanker

Spir4 said:

My question basically boils down to this: does the interest you earn on saving accounts (be it tax free or not) adds to your income and can push you into a higher tax bracket and even reduce your Personal Allowance?

Outside wrappers like ISAs, savings interest is taxable income, even if taxed at 0%, so it's not 'tax-free' as such, which may seem pedantic but is an important distinction relevant to your question.

Spir4

I was referring to taxable interest indeed, but I didn't think of ISA interest, so you make an interesting point.

So say in Scenario 1, if that interest was from an ISA, your total income would be seen as £100,000 and your PA wouldn't get reduced? You get the £500 without any implications at all?

MikeJXE

 Dazed_and_C0nfused said:

Assuming you are referring to taxable interest, not interest from an ISA then,

1.  Yes.

2.  Yes. 

But pension contributions are an easy way to avoid this.

If the interest is tax free (from an ISA) then you wouldn't count it.

It can also reduce the amount of Married Couple's Allowance due and increase a High Income Child Benefit Charge.

Interesting 

So someone who has a pension of say £14,570 which £2,000 is  taxable (20%) so £400 tax 

Also earns £3000 in savings interest at £0% due to starting rate and savings rate

Because that increases the income

Does that make the tax bill £1000 

Dazed_and_C0nfused

Spir4 said:

I was referring to taxable interest indeed, but I didn't think of ISA interest, so you make an interesting point.

So say in Scenario 1, if that interest was from an ISA, your total income would be seen as £100,000 and your PA wouldn't get reduced? You get the £500 without any implications at all?

You've lost me there 😕

If you have income from employment of £100,000 what use is the £500 savings nil rate band 🤔

Scenario 1:

Your income from employment is £100,000

Bookworm105

Spir4 said:

I was referring to taxable interest indeed, but I didn't think of ISA interest, so you make an interesting point.

So say in Scenario 1, if that interest was from an ISA, your total income would be seen as £100,000 and your PA wouldn't get reduced? You get the £500 without any implications at all?

correct - ISA is always outside of your tax return - that is the whole point of it, does not have to be reported  

what people often misunderstand about the savings interest is that it is not a tax free allowance, it is in fact technically a tax rate band taxed at 0%. So 500 taxable income at 0% tax means taxable income is then 100,500, hence loss of 250 PA

eskbanker

MikeJXE said:

 Dazed_and_C0nfused said:

Assuming you are referring to taxable interest, not interest from an ISA then,

1.  Yes.

2.  Yes. 

But pension contributions are an easy way to avoid this.

If the interest is tax free (from an ISA) then you wouldn't count it.

It can also reduce the amount of Married Couple's Allowance due and increase a High Income Child Benefit Charge.

Interesting 

So someone who has a pension of say £14,570 which £2,000 is  taxable (20%) so £400 tax 

Also earns £3000 in savings interest at £0% due to starting rate and savings rate

Because that increases the income

Does that make the tax bill £1000 

No - if total income is less than £18,570 then those nil-rate bands apply and savings interest will be taxed at 0%.

Bookworm105

MikeJXE said:

 Dazed_and_C0nfused said:

Assuming you are referring to taxable interest, not interest from an ISA then,

1.  Yes.

2.  Yes. 

But pension contributions are an easy way to avoid this.

If the interest is tax free (from an ISA) then you wouldn't count it.

It can also reduce the amount of Married Couple's Allowance due and increase a High Income Child Benefit Charge.

Interesting 

So someone who has a pension of say £14,570 which £2,000 is  taxable (20%) so £400 tax 

Also earns £3000 in savings interest at £0% due to starting rate and savings rate

Because that increases the income

Does that make the tax bill £1000 

there are many places that explain how starter rate for savings operates, it can take a while to get head around the 3 factors involved: a) personal allowance, b) 5k starter rate, and c) 1k "allowance"
read this:
How the starting rate for savings works - Money Saving Expert

Spir4

Dazed_and_C0nfused said:

Spir4 said:

I was referring to taxable interest indeed, but I didn't think of ISA interest, so you make an interesting point.

So say in Scenario 1, if that interest was from an ISA, your total income would be seen as £100,000 and your PA wouldn't get reduced? You get the £500 without any implications at all?

You've lost me there 😕

If you have income from employment of £100,000 what use is the £500 savings nil rate band 🤔

Scenario 1:

Your income from employment is £100,000

So your income from employment is £100,000, that's your total income. You've got £500 interest from an ISA, which  doesn't get added to your employment income to get to your total income. You're total income is still £100,000. If that £500 was interest from a normal savings account, then it would get added.

Thanks Bookworm105 for confirming!

Dazed_and_C0nfused

Spir4 said:

Dazed_and_C0nfused said:

Spir4 said:

I was referring to taxable interest indeed, but I didn't think of ISA interest, so you make an interesting point.

So say in Scenario 1, if that interest was from an ISA, your total income would be seen as £100,000 and your PA wouldn't get reduced? You get the £500 without any implications at all?

You've lost me there 😕

If you have income from employment of £100,000 what use is the £500 savings nil rate band 🤔

Scenario 1:

Your income from employment is £100,000

So your income from employment is £100,000, that's your total income. You've got £500 interest from an ISA, which  doesn't get added to your employment income to get to your total income. You're total income is still £100,000. If that £500 was interest from a normal savings account, then it would get added.

Thanks Bookworm105 for confirming!

If your only taxable income is £100,000 then you aren't into tapered Personal Allowance territory in the first place.  

If your adjusted net income is £100,500 then you will lose £250 of your Personal Allowance.