What is the Personal Savings Allowance and how could it affect you?
On 3 August 2023, the Bank of England raised the base rate for the 14th consecutive time, bringing it to 5.25%.
One of the positive outcomes of these base rate rises is the higher interest rates that many banks and building societies are offering on cash savings accounts. After years of negligible returns, cash savings are now offering competitive rates.
The increase in rates, though, has put more people at risk of exceeding their Personal Savings Allowance (PSA). This is the amount of interest you can generate on savings before it becomes liable for Income Tax.
When interest rates were lingering around the 0.1% mark back in 2021, the PSA posed little risk as you’d have needed a large sum of money in cash to generate interest near the threshold.
But, as some of the top rates in early August 2023 exceeded 4.6%, the threshold could be creeping closer for many.
So how does the PSA work and what can you do to minimise your tax liability? Here’s what you need to know.
Exceeding the Personal Savings Allowance means you may need to pay Income Tax on interest earned on your money
Depending on which tax band you are in, the amount of interest you can earn on your savings before Income Tax becomes payable differs.
In the 2023/24 tax year, the PSA is as follows:
£1,000 for basic-rate taxpayers
£500 for higher-rate taxpayers
£0 for additional-rate taxpayers.
This might seem like a lot for basic- and higher-rate taxpayers, but the highest interest rates available at the moment mean it wouldn’t be too difficult to exceed these thresholds.
According to MoneySavingExpert, the following amounts held in the top savings accounts as of 18 July 2023 would exceed the PSA in a year:
Source: MoneySavingExpert
Note that this assumes you aren’t paying in additional deposits and that you take your interest either monthly or annually.
The Personal Savings Allowance relates to interest you have access to in that tax year
It’s important to note that the PSA only relates to interest you’ve generated in that tax year. If you take your interest monthly or annually, then it will count towards your PSA for the year in which the interest is generated.
Some accounts allow you to take interest on the balance at maturity – for example if you choose to lock your savings away for a fixed amount of time. If this is the case, the interest generated will count towards your PSA in the year that the account matures.
Your bank or building society usually pays you gross interest, which means they don’t deduct the tax owed from the amount. Instead, if you owe any tax on your savings, HMRC may amend your tax code so that your Personal Allowance for the tax year is lower.
This means you’ll pay the Income Tax owed on your interest over the course of the year. Alternatively, you can pay the tax owed through your self-assessment tax return.
Tax-efficient savings wrappers could help you to minimise your tax liability
Fortunately, there are several ways to save tax-efficiently if you think you may be at risk of exceeding the PSA.
1. Cash ISA
A Cash ISA can be a helpful way to save as any interest generated on your money is paid free of Income Tax, regardless of your personal tax band.
You can deposit up to £20,000 into an ISA in the 2023/24 tax year. There are a range of options to choose from, including easy access Cash ISAs and fixed-term ISAs that lock away your money for a certain period of time typically in return for a higher interest rate.
2. Premium Bonds
National Savings & Investments (NS&I) offer Treasury-backed Premium Bonds as an alternative way to hold cash savings. Rather than offering an interest rate, each £1 bond that you buy is entered into a monthly prize draw.
Prizes on offer range from £25 to £1 million. If you win, your prize is paid to you tax-free. While there’s no guarantee of a win – it’s possible to hold Premium Bonds for many years and not win anything – the tax benefits mean Premium Bonds could be worth considering.
3. Pension contributions
You’ll usually receive tax relief on contributions you make to your pension at your marginal rate. This means you effectively pay no Income Tax on the income you use to make your contributions. This makes your pension an extremely tax-efficient way to save, as well as having the added bonus of helping you to build up your retirement savings for later in life.
There are some important points to bear in mind when contributing to your pension. Money saved into a pension is not normally accessible until you reach 55 years of age (rising to 57 from April 2028).
Additionally, there is risk involved in saving into your pension. It will usually be invested in a range of different asset classes including stocks and shares, which means you could get back less than you invested.
A financial planner can help you to grow your wealth tax-efficiently
It’s sensible to consult with a financial planner if you’re concerned about how your tax position could affect your wealth and your ability to hit your financial goals.
They can explain the options available to you, and help you to choose the most suitable wrappers for your savings based on your individual circumstances and goals.
If you’d like to speak to a reliable financial planner in Towcester about how to grow your wealth tax-efficiently, we can help. Email theteam@fortitudefp.co.uk or call us on 01327 354321.
Please note
The Financial Conduct Authority does not regulate NS&I products.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.