For the tax year ending 5 April 2009 (2008/09) there have been some major changes to tax rates. We'll go through them now step by step so you can work out how they apply to you.

Earnings or non savings income

• Firstly we look at tax on your non savings or earned income and this includes amongst other things – wages, pensions, taxable state benefits and self employed profits. It does not include savings income which we look at next. After taking off your allowances and any allowable expenses you pay tax up to a limit of £34,800 at the rate of 20% (called basic rate) .

• It is worked out like this:

  Earned income (wages & pensions etc. added together) less your tax free personal allowance gives you your taxable income (income you pay tax on)

• You then tax the taxable income at 20% up to the limit of £34,800. Any earned income above this amount is taxed at higher rates. There is more on higher rates here.

Have a look at example 1

Savings income

• Your savings income is regarded as the part of your taxable income which is taxed next. For 2008/09 and later years there will be a new 10% starting rate for savings income only. The 10% band is limited to £2,320 of savings income.

Upper & lower limits

• What this means as a general rule (there may be some cases where this doesn't apply e.g. if you have work based expenses you can claim – so this is just intended as a basic guide) is that if you have total income including savings of:

  • between £6,035 and £8,355 for those aged 64 and under
  • between £9,030 and £11,350 for those aged 65–74 or
  • between £9,180 and £11,500 for those over 75

– the savings rate will apply to at least part of your income.

• If you are also receiving Blind Person's Allowance which is £1,800 for 2008/09 – the upper limits will be increased by this amount and you will get the savings rate if your income is:

  • between £6,035 and £10,155 for those 64 and under
  • between £9,030 and £13,150 for those aged 65–74 or
  • between £9,180 and £13,300 for those over 75

• So how do you work out tax on savings? Looking at it simply it depends entirely on how much earned income you have.

(a) Only savings income

• If you have no earned income – pensions, wages or taxable state benefits etc – and all your income is savings income – you will get your tax free personal allowance against part of your income and the next £2,320 will be taxed at 10% (the starting rate for savings) with any balance being taxed at 20%.

Have a look at example 2

(b) Non savings (earned income) is above the Upper limit for the savings rate

• If your taxable non–savings income (i.e. earnings, pensions and taxable state benefits etc) is more than the upper limits shown above the 10% savings rate will not be available and your savings income will be taxed in full at 20%.

Have a look at example 3

(c) Non savings income is less than your tax free allowances

• If your non savings income is below your tax allowances – basically this means that you will get some of your tax free personal allowance to set against your savings income.

• You will then get the next £2,320 of savings income taxed at the 10% rate (starting rate for savers) and any balance of savings will then be taxed at 20% basic rate.

• As you will have paid tax at 20% on your interest before you get it – you will need to reclaim tax each year. Have a look at some examples of how this works:

Thomas from the previous example still has income of £10,000 but we will have a look at how his tax changes depending on whether the income is earned income or savings.

Have a look at examples 4–6

(d) Non savings income falls inside the lower and upper limits

• If you have used up your tax free personal allowance against your non savings income but your remaining non savings income is less than £2,320 – you can use the balance of the £2,320 against your savings income at the 10% rate. You are then taxed on the balance of your savings income at 20%.

Have a look at example 7

• Use the link for more information on taxing bank and building society interest

Mainly for those over 65 – you can see a lot more examples of how the starting tax rate for savings and the basic rate of tax will work for 2008/09 and later years here.

Dividends

• If you do not pay tax at 40% (see below) then all your dividends or distributions from unit trusts (but not interest) are taxable at the 10% rate only. They form the very last part of your income and so are taxed at your highest rate of tax. If you pay tax at 40% on your other taxable income you will pay tax at 32.50% on your dividends.

• Use the link for more information on taxing dividends.

Higher rate tax

• Taxable income over £34,800 will be taxed at the 40% higher rate (apart from dividends) whether or not it is savings income.

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