Guide to savings accounts
3. Tax and UK savings accounts
UK Income Tax
Any money you are paid in interest on your current and savings accounts is classed as income by the Inland Revenue. This means you will have to pay tax on the interest earned.
The amount of tax you will pay depends on how much taxable income you have.
Every adult in the UK is entitled to a tax-free allowance. This changes each tax year (the tax year runs from April to April) but currently stands at £5,435. You will not have to pay tax on anything you earn up to this amount.
Anything you earn over this amount is taxable income. The tax you then pay is based on a band system as follows (on these amounts above £5435):
Taxable Bands Allowances 2008-09 (£)
Basic rate = 20% 0 - 36,000
Higher rate = 40% over 36,000
If you earn £14,000 you will not pay tax on the first £5,435. On the next £8565, you will pay 20% tax.
This is important in relation to the tax you will pay on any interest earned in a savings account because the tax band you fall into will determine the percentage of tax charged on your interest.
If, for example, you earn £5,436 (this is £1 over the tax-free allowance - we have used this exact figure for illustrative purposes), anything you earn in interest on your savings will be charged at the basic rate of 20% because this income will have pushed your total income into the higher banding.
How do they calculate how much tax I have to pay on interest earned in a savings account?
Some savings accounts allow you to earn tax-free savings. Look out for ‘Tax-free’ in the savings accounts descriptions later in the guide as a clear indicator of where you can save without paying tax on your interest.
If you don’t earn more than the tax-free allowance each year through a salary, any interest you earn (up to £5,435) will be tax free.
However, you will only get your savings tax-free if you fill out form R85 and give this to your bank. This form will be your way of telling the bank that you earn below the tax-free allowance and therefore do not have to pay tax on interest earned from your savings.
To work out how much tax you pay on your interest (if it is not done automatically – most of the time it is) you can use a simple formula. However, first, you need to look at which tax band your interest will be charged at by looking at the table above (if your salary is £21,000, for example, then the tax charged on your interest will be at 20%).
Banks only pay interest at the basic rate of tax of 20% (they will not charge 40% tax on interest earned).
If you fall into the ‘Starting rate’ band, you will be paying too much tax on your savings’ interest. You can claim this back from the Inland Revenue using form R40.
If you fall into the ‘Higher rate’ band, you will be paying too little tax on your savings interest. You will have to declare this when you do your tax return and pay the additional 20%.
To get an idea of how much tax you will pay on your savings interest you need to multiply the gross interest earned (not including your original deposit) by:
0.9 - If you are in the ‘Starting rate’ band (earn between £0 and £7,455)
0.8 - If you are in the ‘Basic rate’ band (earn between £5,436 and £41,435)
0.6 - If you are in the ‘Higher rate’ band (earn anything over £41,436)
In Example 1 above you would calculate the tax as follows:
Interest earned = Figure after 12 months – Original deposit
= £1,052.50 – £1,000
= £52.50
Net interest earned = Gross interest earned x relevant band figure (as above)
= £52.50 x 0.8 (‘Basic rate’ band figure)
= £42.00
Tax paid = gross interest – net interest
= £52.50 - £42.00
= £10.50
- Next page: Opening a savings account
- Previous page: Savings accounts and interest rates
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Guide contents
- What is a savings account?
- Savings accounts and interest rates
- Tax and UK savings accounts
- Opening a savings account
- Adding money to a savings account
- Accessing money in a savings account
- Regular savings accounts
- Instant access savings accounts
- Online savers
- Individual savings accounts (ISAs)
- Helpful links for further savings information