20% tax band question re tax free allowance for bank interest

StormFrenzy

Basic Rate 20% is up to £37700. I'm lucky enough to earn bank interest and unfortunately with state and private pensions have just tripped into the 40% Rate. My 2024/25 tax calculation, states my Basic Rate 20% is £37200. After querying with HMRC they sent me a letter stating:

You can earn £37700 @ 20%. The first £500 of your tax-free allowance for bank interest is tax free, but still classed as income. This is the reason why the amount you see is £37200 and not £37700.

Would be grateful if somebody who knows about these things could advise me if this is correct? It seems to me by reducing the band by £500 it is the same as paying tax on what is a tax free allowance?

eskbanker

The personal savings allowance is actually a nil-rate band, so the relevant interest is taxable income but is taxed at 0%, rather than being 'tax-free' as such.

StormFrenzy

Slightly concerning that HMRC have used the term tax-free in their letter. It doesn't give me a lot of confidence in the answer they have given me which is typed out verbatim in my original post.

My tax calculation is:
£500 - Personal Savings Allowance at 0%
£37200 - Basic rate at 20%
Small amount  - 40%

By reducing the 20% Basic Rate by £500 it has pushed £500 in the 40% band. This is what I can't get my head around.

Nomunnofun1

StormFrenzy said:

Slightly concerning that HMRC have used the term tax-free in their letter. It doesn't give me a lot of confidence in the answer they have given me which is typed out verbatim in my original post.

My tax calculation is:
£500 - Personal Savings Allowance at 0%
£37200 - Basic rate at 20%
Small amount  - 40%

By reducing the 20% Basic Rate by £500 it has pushed £500 in the 40% band. This is what I can't get my head around.

P

That is correct - despite being charged at 0% the £500 does use up £500 of your basic rate band. 

DRS1

Stupid question

There is an order to the taxation of income.  Savings income comes before Dividend income but after non savings non dividend income.

So if the OP's only other income is pensions shouldn't the savings income be taxed last (and arguably use up the 40% band?)  Of course he doesn't say how  much is in the 40% band or whether it is savings income

Dazed_and_C0nfused

DRS1 said:

Stupid question

There is an order to the taxation of income.  Savings income comes before Dividend income but after non savings non dividend income.

So if the OP's only other income is pensions shouldn't the savings income be taxed last (and arguably use up the 40% band?)  Of course he doesn't say how  much is in the 40% band or whether it is savings income

It's possible that allocating £500 of the Personal Allowance to the interest might generate a better outcome.

That would mean the full basic rate band was used by the pension income and the £500 savings nil rate band would fall into the higher rate band.

But we would need the split of taxable income to know for certain.

Non savings non dividend
Savings interest
Dividends (of there are any)

StormFrenzy

My income is pensions, dividends ~£250pa and savings interest ~£5000pa in 2024/25. The savings and interest take me into the 40% bracket by about £700.

So the calculations are as follows:

Earnings	50970
Allowance	12570
Interest	500	0
20%	37200	7440
40%	700	280

If I had earned £700 less calculations would have been:

Earnings	50270
Allowance	12570
Interest	1000	0
20%	36700	7340

So that that £700, increased tax by £380!

TheSpectator

StormFrenzy said:

My income is pensions, dividends ~£250pa and savings interest ~£5000pa in 2024/25. The savings and interest take me into the 40% bracket by about £700.

So the calculations are as follows:

Earnings	50970
Allowance	12570
Interest	500	0
20%	37200	7440
40%	700	280

If I had earned £700 less calculations would have been:

Earnings	50270
Allowance	12570
Interest	1000	0
20%	36700	7340

So that that £700, increased tax by £380!

Have you included thw dividends and interest in your 'earnings' figure? If so, why. What ia the split between all 3 sources?

StormFrenzy

£45970 earning £5000 savings. £250 dividends not included in earning figure.

Bookworm105

StormFrenzy said:

So that that £700, increased tax by £380!

not quite,
700 income above BR threshold incurs 40% tax 280
and by being above BR threshold you "lose" 500 of the PSA so instead of getting 1000 tax free you only get 500 tax free leaving the "lost" 500 @ 20% = 100 hence 380 "extra" tax 

That 500 at 20% is because interest is the top slice of your income so +500 is now part of the top slice that gets you from (earnings 45970 - PA 12570) 33,400 to the BR threshold 37,700 (37700-33400= 4300). Therefore, in essence, the "lost" 500 now falls into the BR tax band and depending on your choice of words has either "reduced" the BR tax band or is "included" in the BR tax band.

Personally I prefer inclusion rather than reduction 

Look at it this way:
Earnings 45,970 - PA 12,570 = 33,400 @ 20% = 6,680 tax
Top slice 5,000 gross interest 
balance between earnings and threshold 37,700 - 33,400 = 4,300 
5000 interest - 500 PSA = 4500 of which 4300 is @ 20% (=860) leaving 200 @ 40% (= 80) total tax 940
Total tax 6680+940 = 7,620

reduce your interest by 700 to 4,300 and the figures become total incomes 45970 earnings +4300 interest = 50,270 so all BR and thus "full" PSA
tax on earnings unchanged 6,680
4300 interest  - 1000 PSA = 3300@20% = 660 
total tax 7,340

Impact of extra 700 interest 940-660 = 280 not 380

sense check 280/700 = 40% which is right because that 700 is all above the HR threshold but is also effectively net of the (reduced) PSA