Chris Irwin, Director of Savings at Yorkshire Building Society, explains how the Personal Savings Allowance (PSA) works, and gives some tips on the best way to make the most of your savings.
Depending on your tax bracket, your Personal Savings Allowance (PSA) allows you to save up to £1,000 a year in tax-free interest. After a decade or more of lack-lustre savings rates, you may have been fooled into thinking saving wasn’t worth the effort.
But even in a low interest rate environment having a regular savings habit helps to build a buffer you could turn to should the worst happen.
Maybe you’ve already felt that ‘worst’ happen when the pandemic hit or now, through the current cost-of-living crisis, struggling to stretch your monthly income and having to rely on any money in the bank to heat homes and put food on the table. Hopefully having a safety net to fall back on has provided some relief.
For those who have been able to continue to save throughout these harder times, as rates increase, there’s perhaps been an unexpected twist – people who can, are saving more. While that’s great news for anyone who can relate, as interest rates have increased higher than they have been in many years it may mean that if you are not careful you may have to pay tax on your nest egg. That’s because despite savings rates rising, the Personal Savings Allowance hasn’t changed since it was introduced eight years ago – something many may not even know about.
What is the Personal Savings Allowance?
The Personal Savings Allowance was introduced in April 2016. If you’re a basic rate taxpayer you can earn up to £1,000 a year in interest without having to pay any tax, or £500 if you’re a higher rate taxpayer. Additional rate taxpayers don’t receive any allowance at all.
Your ‘savings income’ includes account interest from the following:
- Bank and building society accounts
- Accounts with credit unions or National Savings and Investments
- Annuity payments you’ve purchased
- Government or company bond income
- Interest distributions from authorised units, but not dividends.
As we will explore, interest earned on ISA accounts does not count towards your Personal Savings Allowance, as these savings are already tax-free.
What does that mean?
In a rising rate environment, where savings rates have increased from 0.25% to over 5.00%, the amount you can set aside before paying tax on your interest earned has significantly reduced.
As an example, a basic rate taxpayer saving in an account paying the lowest of these rates would have needed £400,000 in a savings account before tax was due on the interest. Now though, in an account paying 5.50% the same person would need just over £18,000. For higher rate taxpayers those figures drop from £200,000 (account paying 0.25%) to £9,000 (account paying 5.50%).
Sadly, if people don’t understand the rules, there’s every chance you may be penalised without even realising it.
So that’s the problem, what’s the solution?
- Educate – it may sound simple but find out about the PSA rules and limits, having a better understanding will help you see how these rules might affect you. Talk to your savings provider who may offer a savings review. This will ensure that you have the right account for whatever you’re saving for.
- Review – Make sure you are making the most of your money. Talk to your savings provider as they could be a really helpful at understanding your financial aspirations and help you achieve them with more suitable accounts. Whether that’s establishing a routine with a regular saver, supporting a saver to find an account which offers more value or transferring taxable chunks of money from high value accounts into those with a tax-free wrapper such as an ISA, there’s things we can be doing.
- Tax-Free –Make the most of your tax-free allowances. Basic-rate taxpayers can earn £1,000 savings interest a year in savings accounts without paying tax (higher-rate taxpayers can earn £500) but any interest earned on your ISA doesn’t count towards this allowance. It also lets you enjoy the effects of compound interest tax-free which makes it efficient for long-term saving. If you’ve got a lot of savings, it’s worth having an ISA in addition to your personal savings allowance.
It’s important when it comes to building financial resilience that we support and develop savers’ understanding on things like tax-free savings.
It’s not a question of one or the other; shrewd savers could use both savings vehicles and consider making an ISA account their first port of call as it may offer better rewards over the long term – especially as rates have risen. Savers can then make the most of their PSA if they are able to make any additional savings that year.
Whatever home you chose for your savings, make sure you make the most of them without having to pay unnecessary tax.