To use regular savers or not

Dazed_and_C0nfused

RexItaliae said:

clairec666 said:

Simple calculations here, can't guarantee it's the optimum strategy...

A regular saver offering 7% interest is "equivalent" after tax at 40% to an ISA with 4.2% interest. 6.5% is equivalent to 3.9%, and so on.

Maxing out three of the highest regular savers for a year will probably bring in £350+ in interest, which with the £100 Nationwide bonus brings you close to your £500 limit. So any extra regular savers you open (which will likely be 6.5% downwards) are going to be taxed on most of their interest. If you're getting more than 3.9% in the ISA, put the money in that instead.

I agree on 7% gross RS = 4.2% ISA. However, consider the following scenario:

Suppose I have 5 regular savers: 3 of them on 7%, and 4 of them at 6.5%, and my ISA gives me a 4% interest. Suppose I earn £500 gross in total from the top 3, and another £500 from the bottom 4. You suggested to keep the top three RS, and in fact ditch the bottom four because once taxed they give me less than I'd get if I had put the money in the ISA.

However, another way I can look at the situation is: I can "pretend" that the interest matured on the top three RS at 7% is taxed which means I get a net 4.2% interest out of them, whereas the interest matured by the bottom five accounts is within my £500 threshold and therefore not taxed. Now I feel like I would miss out if I had the money maturing £500 interest at 6.5% in a cash ISA which yields only 4%. Would this way of "looking at the situation" be mathematically correct?

I guess what I mean to ask is: in a situation when one goes beyond the tax-free threshold, should one consider the interest matured by the highest-paying accounts to be "beyond the threshold", or should one consider the interest matured by the lowest-paying accounts to be beyond the threshold?

You also need to remember if it's not from an ISA it's not actually "tax free" for an ever increasing number of people.

Tapered Personal Allowance, HICBC and Married Couple's Allowance are all long standing situations where interest taxed at 0% can add to your overall tax liability.

As it can do for those with pre 6 April 2016 State Pension deferral lump sums.

And starting this tax year £1 of interest taxed at 0% could cost an elderly Scottish pensioner £305.10 as a result of the new Winter Fuel Payment tax charge.

clairec666

RexItaliae said:

clairec666 said:

Simple calculations here, can't guarantee it's the optimum strategy...

A regular saver offering 7% interest is "equivalent" after tax at 40% to an ISA with 4.2% interest. 6.5% is equivalent to 3.9%, and so on.

Maxing out three of the highest regular savers for a year will probably bring in £350+ in interest, which with the £100 Nationwide bonus brings you close to your £500 limit. So any extra regular savers you open (which will likely be 6.5% downwards) are going to be taxed on most of their interest. If you're getting more than 3.9% in the ISA, put the money in that instead.

I agree on 7% gross RS = 4.2% ISA. However, consider the following scenario:

Suppose I have 5 regular savers: 3 of them on 7%, and 4 of them at 6.5%, and my ISA gives me a 4% interest. Suppose I earn £500 gross in total from the top 3, and another £500 from the bottom 4. You suggested to keep the top three RS, and in fact ditch the bottom four because once taxed they give me less than I'd get if I had put the money in the ISA.

However, another way I can look at the situation is: I can "pretend" that the interest matured on the top three RS at 7% is taxed which means I get a net 4.2% interest out of them, whereas the interest matured by the bottom five accounts is within my £500 threshold and therefore not taxed. Now I feel like I would miss out if I had the money maturing £500 interest at 6.5% in a cash ISA which yields only 4%. Would this way of "looking at the situation" be mathematically correct?

I guess what I mean to ask is: in a situation when one goes beyond the tax-free threshold, should one consider the interest matured by the highest-paying accounts to be "beyond the threshold", or should one consider the interest matured by the lowest-paying accounts to be beyond the threshold?

Ah, I see what you mean. I think I pondered the exact same issue with my own savings, but didn't get round to crunching the numbers (I'm a basic rate taxpayer so the regular saver usually wins anyway).

Without pumping all the numbers into a spreadsheet, I guess the neatest way of looking at it mathematically is this:
The taxman doesn't care which regular saver you're paying tax on, only on the total amount. So when adding more regular savers you should take an average of the interest rates (if you want to be super-accurate, take a weighted average based on how much you can put in each month) then compare this to your ISA rate.
Quick example - if you have 3 regular savers at 7%, then add another at 6%, then rather than comparing the 6% to the ISA rate you should compare 6.75%.
In general this makes regular savers look a better option than they did with my previous crude method.

Catplan

friolento said:”

RexItaliae said:

This year for the first time I'll be earning more than the 40% income tax threshold, so I can only earn up to £500 tax-free interest.

My strategy is to have enough RS accounts making me reach the £500 interest threshold, and keep the rest of my savings in the best easy access cash ISA I can get. (I won't reach the 20k ISA limit this year for sure.) To do this I use a spreadsheet similar to the ones seen in this thread, which counts the monthly interest yielded by each account, and I add them all up across the tax year. Interestingly this year I had to stop paying into some of my RS before reaching month 12 because of the Nationwide Fair Share payment of £100 (which counts as savings) that made me reach the £500 target earlier than expected.

I know that now there are RS accounts whose net rate (for me being only 60% of their AER gross rate) is higher than the best easy access cash ISA, but I'm not sure what this implies in terms of what's best to do: should I open all the RS whose annual interest rate x 60% is higher than the best easy access cash ISA I can get, and then on top of those add as many RS I can open that would mature £500 in total within the current tax year (or whatever the value of "500 - Nationwide Fair Share" is)? I'm not sure, but I suspect the difference between this and my simpler strategy above would be a matter of a few pounds.  

Assuming you expect to remain a HR tax payer, my strategy would be to maximise my ISA contributions to as near as £20k as possible. Whilst this might lead to a little lower interest in the short term, in the medium and longer term ISAs should be to your advantage. If you choose a flexible ISA, if your RS(s) allows penality-free withdrawals or closure, and if you don't mind the extra admin, you can get the best of both worlds.

Or salary sacrifice (if available) to bring you back below HR tax bracket if you can.

Also consider what tax year the interest is paid, anything open before April 5th is likely to be included this year.

RexItaliae

clairec666 said:

The taxman doesn't care which regular saver you're paying tax on, only on the total amount. So when adding more regular savers you should take an average of the interest rates (if you want to be super-accurate, take a weighted average based on how much you can put in each month) then compare this to your ISA rate.
Quick example - if you have 3 regular savers at 7%, then add another at 6%, then rather than comparing the 6% to the ISA rate you should compare 6.75%.

When you say "compare this to your ISA rate", do you mean "compare this x 60% to your ISA rate"? If yes, wouldn't this be the correct way of thinking, in the assumption that I had to pay tax on ALL interest earned from the regular savers? Here though we're assuming that the "first" £500 is not taxed, only anything beyond this is. Which is what confuses me.

I agree that of course the taxman doesn't care which account generates interest, but I can't think of the mathematical way that would capture this while also taking into account that part of the interest earned is not taxed. Therefore I can't think of a way to properly decide if I should open a particular regular saver knowing how much interest I will be maturing with all the other RS already in the tax year.

masonic said:
You should consider the accounts being taxed to be those you'd drop if you didn't have the capital. You wouldn't remove money from the highest paying accounts if there were lower paying accounts you could sacrifice.

Why is this correct though? I have a vague intuition that it should be, but I wouldn't know how to prove it.

clairec666

RexItaliae said:

When you say "compare this to your ISA rate", do you mean "compare this x 60% to your ISA rate"? If yes, wouldn't this be the correct way of thinking, in the assumption that I had to pay tax on ALL interest earned from the regular savers? Here though we're assuming that the "first" £500 is not taxed, only anything beyond this is. Which is what confuses me.

Yeah, I meant compare the adjusted rate (i.e. x 60%) with the ISA rate.

Been playing around with a spreadsheet to try and get my head around the "averaging" idea but it's confusing me so I'll have a proper look in the morning!

clairec666

RexItaliae said:

I guess what I mean to ask is: in a situation when one goes beyond the tax-free threshold, should one consider the interest matured by the highest-paying accounts to be "beyond the threshold", or should one consider the interest matured by the lowest-paying accounts to be beyond the threshold?

It's the latter - just consider the lowest-paying accounts. Forget my idea of averaging across all your accounts. What masonic said a few posts back explains it. I've played around with a few examples in a spreadsheet to make sure it all works. So basically once you've used up your £500 (or substitute any threshold here if bonuses are eating into it), only open regular savers that pay more than your ISA rate divided by 0.6 (or 0.8 for basic rate taxpayers). Nice simple calculation. I was over-complicating things with the averaging idea and it didn't even work properly

TheBanker

friolento said:

RexItaliae said:

This year for the first time I'll be earning more than the 40% income tax threshold, so I can only earn up to £500 tax-free interest.

My strategy is to have enough RS accounts making me reach the £500 interest threshold, and keep the rest of my savings in the best easy access cash ISA I can get. (I won't reach the 20k ISA limit this year for sure.) To do this I use a spreadsheet similar to the ones seen in this thread, which counts the monthly interest yielded by each account, and I add them all up across the tax year. Interestingly this year I had to stop paying into some of my RS before reaching month 12 because of the Nationwide Fair Share payment of £100 (which counts as savings) that made me reach the £500 target earlier than expected.

I know that now there are RS accounts whose net rate (for me being only 60% of their AER gross rate) is higher than the best easy access cash ISA, but I'm not sure what this implies in terms of what's best to do: should I open all the RS whose annual interest rate x 60% is higher than the best easy access cash ISA I can get, and then on top of those add as many RS I can open that would mature £500 in total within the current tax year (or whatever the value of "500 - Nationwide Fair Share" is)? I'm not sure, but I suspect the difference between this and my simpler strategy above would be a matter of a few pounds.  

Assuming you expect to remain a HR tax payer, my strategy would be to maximise my ISA contributions to as near as £20k as possible. Whilst this might lead to a little lower interest in the short term, in the medium and longer term ISAs should be to your advantage. If you choose a flexible ISA, if your RS(s) allows penality-free withdrawals or closure, and if you don't mind the extra admin, you can get the best of both worlds.

My strategy is to use Regular Savers where the net interest (i.e. after paying 40% to the government) is still more than the gross Cash ISA rate. Then at the end of the tax year I draw down from the lowest paying RS accounts to top up my ISA to £20k. There is value in using the ISA allowance in full each year, especially given the current speculation that the cash ISA allowance may reduce at some point in the future. A complication for me this year is that I have a Sharesave plan maturing in October and I want to transfer the shares into my ISA to avoid CGT liability.

If you trying to minimise tax liability, you also need to be mindful of which tax year your RS interest will be paid in, as some (e.g. Zopa) pay it monthly, but it's more common to receive a single payment on maturity. 

The main thing, I think, is to keep a tracker of how much interest you've earned so you can work out your tax liability. A lot of people seem to get caught out because they don't keep track, then receive an unexpected tax bill - which can take a long time to arrive if you're not doing Self Assessment. 

masonic

RexItaliae said:

masonic said:
You should consider the accounts being taxed to be those you'd drop if you didn't have the capital. You wouldn't remove money from the highest paying accounts if there were lower paying accounts you could sacrifice.

Why is this correct though? I have a vague intuition that it should be, but I wouldn't know how to prove it.

It's like your marginal rate of tax, which is the rate of tax that would be applied to your next pound of income. In this case, you're considering your marginal savings rate, which is the rate that you'd earn on the next pound you saved above your personal savings allowance. If you are acting rationally, you'd start with the lowest amount of savings that could earn £1000 in the best available accounts, all of this being taxed at 0%, then consider where you'd put the next taxable pound of savings. That is the first pound of savings that will have its interest taxed. Your marginal savings rate will therefore correspond to one of your lower rate accounts, and each next pound saved will contribute to filling this and reducing your rate further. If there was a tax shelter you could use to reduce your tax liability, such as a cash ISA, if you were acting rationally, you'd remove savings from the lowest paying accounts as a priority to fill this new one, not withdrawing from an account paying 7% when you have one paying 4%.

surreysaver

clairec666 said:

RexItaliae said:

I guess what I mean to ask is: in a situation when one goes beyond the tax-free threshold, should one consider the interest matured by the highest-paying accounts to be "beyond the threshold", or should one consider the interest matured by the lowest-paying accounts to be beyond the threshold?

It's the latter - just consider the lowest-paying accounts. Forget my idea of averaging across all your accounts. What masonic said a few posts back explains it. I've played around with a few examples in a spreadsheet to make sure it all works. So basically once you've used up your £500 (or substitute any threshold here if bonuses are eating into it), only open regular savers that pay more than your ISA rate divided by 0.6 (or 0.8 for basic rate taxpayers). Nice simple calculation. I was over-complicating things with the averaging idea and it didn't even work properly

What I do, if you know you're going to be going over the allowance regardless, just open accounts where the net interest is more than what you'd get in an ISA until you've used up your ISA allowance, then open other accounts offering lower interest.
I'd only start doing complicated spreadsheets and working outs if I was going to be borderline 

slinger2

My 6 month Regular Saver with Principality (8% AER) matured today. £1,231 appeared in my bank account, 6x£200 monthly payments plus £31 interest. I'll be paying 20% tax on the interest, so that leaves £25. I could have left it in an easy access account and got £15 or so, so my "profit" is £10. Is it worth it for the hassle of opening the account, making 6 payments, giving maturity instructions, etc? Probably not (I always tell myself) but it's harmless entertainment.

(6+5.45+4.45+3.45+2.45+1.45)/12*£200*8% = £31