Savings

Updated on 9 December 2019

Other tax issues

Here, we look in detail at common types of savings income, including bank and building society interest, and dividend income. For a brief overview of the taxation of savings and dividend income check out our factsheet Savings and dividend tax. For information on the Help-to-Save scheme, please see our dedicated page.

What is bank or building society interest?

When you put your money into a bank or building society account, it may earn interest. Interest is money the bank or building society pays you in recognition of the fact that they hold (and have use of) your money.

Interest counts as income for tax purposes on the date it is credited to your account. Most bank and building society income is taxable.

Normally, we might think of ‘income’ as something that is 'earned’ – for example, income from your job or from self-employment – however bank or building society interest is a form of passive income. It is taxed differently to earned income.

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How is bank and building society interest taxed?

In 2019/20, most people will have no tax to pay on interest they receive from a bank or building society account due to the ‘personal savings allowance’ (PSA) of £1,000 (or £500 for higher rate taxpayers). Additional-rate taxpayers are not entitled to any PSA. The PSA was introduced from 6 April 2016.

Savings income that falls into your PSA is taxable at 0%, which means you have no tax to pay on it.

Beyond the PSA the basic rate of 20%, the higher tax rate of 40% or the additional rate of 45% may apply, unless the income is specifically tax free. When looking at which rate band may apply to your savings income, you should remember that savings income is treated as the top slice of taxable income, apart from dividend income.  

For a basic example of how the PSA works, see Henry.

If you live in Scotland and are a Scottish taxpayer, you pay tax according to UK rates and bands on your savings income. For information on how the PSA works for Scottish taxpayers in 2019/20, see below.

You should note that income within your PSA is counted as taxable income (albeit taxable at 0%) and so still counts towards your basic or higher rate limits – and may therefore affect things like the amount of PSA that you are entitled to in the first place, the rate of tax that is due on any savings income you receive in excess of this allowance and the rate of tax you pay on dividend income (see What tax rates apply to me? for more information).

In addition, because the income is still counted as taxable income (albeit taxable at 0%) it is counted as income for tax credits purposes. For universal credit purposes, the actual income is ignored and you are deemed to have ‘tariff’ income if your total savings exceeds a certain threshold. For more information, see our page on universal credit.

Please also note that the PSA comes on top of the normal personal allowance and the starting rate for savings (£5,000). These two things taken together mean that anyone with total taxable income of less than £17,500 (for example, from wages, profits, pensions and savings – not including dividends) will generally pay no tax on their bank or building society interest in 2019/20, even without the PSA. The £17,500 figure can be higher if you get blind person’s allowance, marriage allowance or married couple’s allowance.

For an example of how the starting rate for savings interacts with the PSA, see Eric.

The PSA only applies to savings income paid after 6 April 2016. You can find a description of the rules on savings income for the tax years up to and including 2015/16 below.

You can find a basic government factsheet on the personal savings allowance on GOV.UK.

For a more detailed look at the PSA see our factsheet Savings and dividend tax which also includes examples of how savings income within the PSA uses up the rate bands and how the PSA interacts with the dividend allowance.

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What happens if I have to pay tax on my savings interest?

In 2019/20, most people with bank and building society interest will not have to pay tax on their savings income due to the PSA. Banks and building societies will therefore not deduct any tax at source from bank interest and it will be paid gross. Non-taxpayers do not need to complete an R85 form to receive their bank interest gross.

The existence of the PSA and the fact that banks and building societies do not deduct tax at source means the tax position for most people who have modest amounts of savings income is straightforward and delivers the right result in the majority of cases. However, it also means that other people may face a requirement to notify HMRC about their untaxed, taxable savings interest.

If you do have to pay tax on your bank and building society interest, and if you normally complete a tax return, then you can just include the amount of savings income in the relevant section. If you do not normally complete a tax return, you should tell HMRC about the taxable income. If they can, HMRC will take the extra tax you owe from your wages by changing your Pay As You Earn (PAYE) code. If they cannot adjust your tax code, they may send you a bill at the end of the tax year or ask you to fill in a tax return.

HMRC now use information provided to them directly by banks and building societies about any savings interest income you receive. They may use this to send you a bill at the end of the tax year (the P800 form) and/or to amend your tax code. But this will only be for accounts in the name of one individual. Where an account is in joint names, HMRC will not have any information they can use. So, if you have received interest on a joint account, you will need to tell HMRC separately.

Where HMRC are using bank and building society information, you should check your P800 (or coding notices) more carefully than usual to make sure what HMRC are doing is correct – in particular that you have been given the correct PSA. You can read more about this in our news article HMRC are set to use bank and building society information – check it is correct!.

Please note that you should not assume that HMRC will have a similar source of information on all types of income – for example you always need to advise HMRC yourself if you have taxable dividend income.

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More detail on the personal savings allowance

How much is my personal savings allowance? 

The amount of your personal savings allowance depends on your ‘adjusted net income’. This is your total taxable income (including dividends) less certain tax reliefs, for example Gift Aid donations and pension contributions. For 2019/20:

  • If your adjusted net income is up to £50,000, your personal savings allowance is £1,000.

  • If your adjusted net income is between £50,001 and £150,000, you will be entitled to a personal allowance of £500.

  • If your adjusted net income is over £150,000, you will not be entitled to any personal savings allowance.

As you can see, £1 of additional income can cost you £500 of allowance! See our example John and James for an illustration of how important it is to keep an eye on your levels of income in case you stray into a different taxable band, perhaps following a pay rise or other change in circumstances. You should be particularly aware of certain bonds that roll up and credit your interest in one go at the end of the term as all of the interest is counted as income in the year in which the bond matures, which could push you into a higher tax bracket in that tax year.

'Adjusted net income' is described in more detail on GOV.UK.

What other types of savings income does the personal savings allowance apply to?

As well as interest on bank and building society accounts, the personal savings allowance (PSA) applies to other types of savings income, such as:

  • interest from accounts with providers such as credit unions and National Savings and Investments
  • interest included in payments of compensation for mis-sold financial products, such as payment protection insurance (PPI)
  • interest distributions from authorised unit trusts, investment trusts and open-ended investment companies
  • income from corporate bonds and gilts (government bonds)
  • income from certain purchased life annuities, profits from deeply discounted securities; profits under the accrued income scheme
  • gains from certain life insurance contracts
  • foreign interest, unless it is relevant foreign income for remittance basis purposes

Many of these sources of savings income, for example credit union and foreign interest, have always been paid without tax deducted at source. Conversely, other sources have always had tax deducted at source and this will not change.

For example, tax will continue to be deducted automatically from certain forms of savings income such as interest distributions from authorised unit trusts and open-ended investment companies. This is because HMRC is of the view that investors in collective investment schemes are more likely than bank or building society depositors to be higher or additional rate taxpayers, and more likely to receive amounts in excess of the PSA. Tax will also continue to be deducted from interest paid on compensation, for example in the case of mis-selling of PPI, as this is likely to be a large one-off amount and may exceed the PSA.

If the tax deducted at source turns out to be excessive, you may be able to claim the tax back by filling in form R40 (or form R43 if living overseas) and sending it to HMRC. More information about this is available on our page How do I claim back tax on savings income?. We have also published separate guidance on how to claim back tax deducted at source on PPI pay-outs.

If you are unsure as to the extent to which your savings income is taxable, you may need to seek professional advice. We tell you how you can find a tax adviser in our Getting Help section.

My bank account pays ‘rewards’ – does the personal savings allowance apply to them?

The PSA applies only to savings income as defined by law. This means that even if you receive income that you think of as savings income, if it is not within the definition, it is not eligible for the PSA. Equally, it is not eligible for the starting rate of savings.

The situation can be very confusing in relation to certain types of ‘reward’ accounts which many banks offer. If you receive any interest (whether on the reward account or on a different account), you should now receive that gross and it will be eligible for the PSA. The treatment of ‘rewards’ however depends on the nature of the reward. It is very possible that you will receive the reward net of 20% tax; in addition, the reward may not be eligible for the PSA. There is often limited guidance available from the bank, and the nature of the reward can vary from account to account.

Please note that we are talking about regular cash rewards here as opposed to cash incentives for people switching their accounts or cashback on certain types of spending, which are generally not taxable as they are considered a 'discount' rather than a reward.

If you have a reward account, to check the tax position, you need to find out the following information:

  • the type of reward;

  • whether the bank pays you the reward gross or net of tax (and if net, how much tax is deducted at source);

  • whether the reward is taxable income; and

  • whether the reward is potentially eligible for the PSA, depending on your circumstances.

There are three main possible tax treatments, depending on the type of reward:

  1. If the reward takes the form of interest (that is, a rate based on the account balance), it is savings income and eligible for the PSA. Banks should pay this to you gross without deducting 20% tax at source, but it is still taxable income.
  2. If the reward takes the form of a cash reward (not related to the account balance), for say depositing a certain amount per month, this is not savings income, but is probably an ‘annual payment’ (applicable even if reward is paid monthly). Banks must deduct tax at 20% before paying you the cash reward, and the gross amount of the cash reward is taxable. Since annual payments are not savings income, these types of reward are not eligible for the PSA (or the starting rate for savings). If you are not liable to tax you can reclaim any tax deducted by completing an R40 form or on your Self Assessment tax return. If you are a higher-rate taxpayer you would need to pay the extra amount to HMRC, for example, via a PAYE coding adjustment or through your tax return.
  3. If the reward takes the form of a cash reward (not related to the account balance) and there is a fee for the account, the reward does not meet the conditions for an annual payment. It is still taxable, however as 'miscellaneous payment'. Banks do not have to deduct tax before paying you the cash reward, so you receive these rewards gross and the gross amount is taxable. These types of reward are not savings income, so they are not eligible for the PSA (or the starting rate for savings). If you are a basic or higher-rate taxpayer you would need to pay any tax due to HMRC, for example, via a PAYE coding adjustment or through your tax return. 

What does the personal savings allowance mean for cash ISAs and other tax free savings products?

If you have a cash Individual Savings Account (ISA), the interest you get is tax free. ISA income does not count towards the PSA.

There are also a number of NS&I products, distributed by the Post Office and backed by the Treasury, which are expressly free of tax, for example, fixed interest and index-linked National Savings Certificates and Premium Bonds. Income from these products does not count towards the PSA either.

You can find more information about NS&I products on the NS&I website.

How does the personal savings allowance apply to a joint account?

Both account holders are entitled to a personal savings allowance, to use against their share of the interest.

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Savings income for tax years up to and including 2015/16 – for information

For tax years up to and including 2015/16, HM Revenue & Customs (HMRC) asked banks and building societies to take 20% tax off your interest before paying you the rest. The 20% tax was passed directly to HMRC.

For example, if you had £1,000 in a bank account paying 3% interest a year, then the total bank interest you would be paid is £30. This was known as the gross amount. However, the bank would pay £6 (that is 20%) of this to HMRC and would pay you £24. The £24 was known as the net amount. You may have seen the entry ‘net interest’ on your bank statement.  

The rate of tax that a person ultimately had to pay on their bank interest depended on how much other income they had:

  • low-income taxpayers may not have had to pay any tax on their bank interest and so may have been due a refund (see below);
  • 20% or basic rate taxpayers had no more tax to pay;
  • higher rate (40%) taxpayers had to pay a further 20%; and
  • additional rate (45%) taxpayers a further 25%.

Low-income taxpayers

If having 20% tax deducted at source on your bank interest meant that you overpaid tax on your bank interest because of the availability of your allowances or the starting rate for savings, you could claim back tax that had been deducted from your bank interest by completing form R40 (or form R43 if you are living overseas).

For more information on form R40/R43 see our page How do I claim back tax on savings income?.

To stop your savings income being automatically taxed at source, you could have filled out a form R85 and sent it to your bank or building society. The new rules from April 2016 mean that the R85 form is now obsolete.

Higher rate and additional rate taxpayers

Higher rate and additional rate taxpayers would have needed to declare any savings income on their tax return (if they completed one). If they did not normally complete a tax return they would have had to let HMRC know. HMRC would have either asked them to complete a return, or, if they were employed or receiving a pension, may have arranged to collect the extra tax due through Pay As You Earn (PAYE).

Can you tell me more about ISAs?

You can save tax free with Individual Savings Accounts (ISAs).

There are two main types of ISA for you to choose from: cash, in which interest is tax free, and stocks and shares in which dividends on or any capital growth in the stocks and shares are tax free.

You do not need to tell HMRC about income you get from ISAs. ISA income does not count towards the new personal savings or dividend allowances. There is more on ISAs on GOV.UK including information on eligibility for an account.

Since 6 April 2016, interest and gains from qualifying peer to peer loans are eligible for ISA tax advantages in an Innovative Finance Individual Savings Account.

An ISA investor will therefore be entitled to put money into an Innovative Finance ISA, a cash ISA or a stocks and shares ISA – or a mixture. Across all these ISAs, the maximum you can put in in 2019/20 is £20,000.

The Lifetime ISA is another type of ISA. Introduced from 6 April 2017, it aims to help savers under 40 build a deposit for their first home or save until age 60 for retirement, with penalties if used for other purposes. The government will pay a tax-free bonus of £1 for every £4 saved, so somebody who saves the maximum £4,000 a year will get £1,000 on top (this is the same amount as you might get in tax relief if you put £4,000 into a pension).

The £4,000 limit, if used, forms part of your overall £20,000 annual ISA limit. You can find detailed technical guidance on the Lifetime ISA on GOV.UK

If you are interested in opening a Lifetime ISA, interactions with means tested benefits should be considered and you should make sure you understand when you can take your money out and for what purpose.

You may be interested in a report by LITRG Senior Technical Manager, Kelly Sizer, on The complexities of government-incentivised savings schemes for people on low incomes (October 2017). The report looks at these issues in detail across a number of government incentivised schemes, including pensions auto-enrolment, Lifetime ISAs and Help-to-Save. For a summary of the key points, please see our article Solving the savings conundrum.

Please note that ISA rules enable the spouse or civil partner of a deceased ISA saver to benefit from an additional ISA allowance in the year of death, and therefore to have more of their savings tax advantaged. Individuals are permitted to save an additional amount in an ISA (or ISAs), up to the value of their spouse or civil partner’s ISA savings at the date of death, without this amount counting against the normal ISA subscription limit.

Other ISAs

There are also junior cash ISAs and junior stocks and shares ISAs for children under 18 years old. A child can have both types of Junior ISA, provided they do not exceed the annual Junior ISA allowance (£4,368 for 2019/20).

Since December 2015, Help-to-Buy ISAs have been available. They can be opened until 30 November 2019. They are a type of ISA designed to help first-time buyers save up for a deposit for their new home with the government adding a tax-free bonus of up to 25% to all money saved (provided you save a minimum of £1,600, up to a maximum bonus of £3,000). In the 2019/20 tax year, you can save an initial deposit of up to £1,200 and up to £200 each subsequent month.

If you have a Help-to-Buy ISA, you can transfer those savings into a Lifetime ISA or you can continue to save into both. However, you can only use the bonus from one of the ISAs to buy a house. Furthermore, from 2018/19, if you transfer Help-to-Buy ISA savings into a Lifetime ISA they will count towards the £4,000 contribution limit (they did not if the transfer was made in 2017/18).

Finally, although not an ISA as such, a government-incentivised savings scheme, Help-to-Save, was introduced in September 2018 and is aimed at supporting people on low incomes to build up their savings. Over four years, regular savers can deposit up to £50 a month and receive up to £1,200 in tax-free government bonuses.

For more information on who Help-to-Save is for and how it works, see our separate guidance.

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Can you tell me more about credit unions?

A credit union is a financial co-operative. They are traditionally owned and run by members who have a common interest, such as where they live or work; but changes to the Credit Unions Act 1979 effective from 8 January 2012 mean that membership rules are no longer so prescriptive.

Numbers of credit union members have been rising and it is likely that much of this growth is coming from the scores of employers who are partnering with credit unions and facilitating employee savings via payroll deductions.

From October 2019, some credit unions have been piloting a new ‘win while you save’ account known as a PrizeSaver account. It is possible to win up to £5,000 a month by saving £1 a month into these accounts. HMRC have confirmed to us that the winnings paid in these accounts are not treated as taxable income and can therefore be ignored for income tax purposes. However, please note the winnings will be treated as capital for universal credit and your universal credit award would be affected if your total capital exceeds £6,000. If you are in receipt of any tax credits or benefits, you should check with the relevant department to confirm how any prize is treated for that specific benefit.

Returns on savings may be by way of a ‘dividend’ or interest. Both types are treated as interest income for tax purposes despite the first being called a ‘dividend’. Credit unions do not have to deduct any tax at source from savings income. Credit union savings income falls within the scope of the PSA.

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What is a dividend?

If you invest in shares in a company, there are two ways you can earn money. They can grow in value, allowing you to make a gain when you sell them. Companies also distribute the profits they make in the form of a dividend. This is known as dividend income. 

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How is dividend income taxed?

The availability of a dividend allowance means that in 2019/20, most people do not have to pay tax on the first £2,000 of their dividend income. Introduced in 2016/17, the dividend allowance (now £2,000, reduced from £5,000 in 2016/17 and 2017/18) is available to anyone who receives dividend income (including foreign dividends unless they are relevant foreign income for remittance basis purposes) – no matter how much non-dividend income they have.

To the extent that dividend income falls into your dividend allowance, it is taxable at 0%, which means you have no tax to pay on it.

Beyond the allowance, dividends are taxed at 7.5%, 32.5% and 38.1% on basic, higher and additional rate taxpayers respectively. When looking at which rate band may apply to your dividend income, you should remember that dividend income is treated as the top slice of taxable income.

If you live in Scotland and are a Scottish taxpayer, you pay tax according to UK rates and bands on your dividend income. For more information on how the dividend allowance works for Scottish taxpayers in 2019/20, see below.

Taxpayers are not required to notify HMRC of their dividend income if dividends fall within the dividend allowance. However, taxpayers whose dividends are not covered by the dividend allowance have an obligation to notify a liability to pay tax to HMRC (those in Self Assessment should just include the amount of dividend income in the relevant section).

Please note that income that is within your dividend allowance is counted as taxable income (albeit taxable at 0%) and so counts towards your basic or higher rate limits and may therefore affect the amount of PSA that you are entitled to and the rate of tax you pay on dividend income that exceeds your allowance (see What tax rates apply to me? for more information on this).

In addition, because the income is still counted as taxable income (albeit taxable at 0%) it is counted as income for tax credit purposes. For universal credit, dividend income is ignored and your shares are treated as capital. If you have total capital in excess of a certain threshold, you are deemed to have ‘tariff’ income. Please see our page on universal credit for more information.

There is more information about the dividend allowance, including some examples, in the factsheet on GOV.UK.

For a more detailed look at the dividend allowance see our factsheet Savings and dividend tax which also includes examples of how dividend income within the dividend allowance uses up the rate bands and how the dividend allowance interacts with the personal savings allowance.

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Dividend income for tax years up to and including 2015/16 – for information

For tax years up to and including 2015/16, UK dividends were deemed to have been automatically taxed – called 'taxed at source' – at the rate of 10%. The notional 10% tax deducted was called a tax credit.

If a UK company had paid a dividend of £18,000 to a shareholder, the £18,000 was the amount of cash actually received. 10% tax was deemed to have been deducted at source from the dividend, giving a tax credit of £2,000. The total gross amount of the dividend was £20,000.

The tax credit of 10% may not have been the final amount of tax due on the dividend. The rate of tax that you ultimately have to pay on your dividend income depended on how much other income you had.

There were three possible rates of tax which could apply to dividend income: the ordinary rate of 10%, also the dividend upper rate of 32.5% or the dividend additional rate of 37.5%:

  • Basic-rate taxpayer – you had no further tax to pay;
  • Higher-rate taxpayers – you had to pay a further 22.5% of the gross dividend, making a total of 32.5%;
  • Additional-rate taxpayer – you had to pay an extra 27.5% of the gross dividend, making a total of 37.5%.

Higher-rate and additional-rate taxpayers would have needed to declare any dividend income on their tax return if they completed one. If they did not normally complete a tax return they would have had to let HMRC know. HMRC would have either asked them to complete a return, or, if they were employed or receiving a pension, may have arranged to collect the extra tax due through Pay As You Earn (PAYE).

What if I was a non-taxpayer?

If you were a non-taxpayer because your total income from all sources came to less than your allowances, 10% notional tax would have still been deemed to have been deducted from your UK dividends, but you could not claim it back.

It is important to note here that the tax credit associated with the dividend was a notional tax credit. You could use the 10% tax credit to reduce your tax liability, but only to nil. You could not use this tax credit to generate a tax repayment.

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I give to charity under Gift Aid, is there anything I should note about the personal savings allowance and dividend allowance?

You may have been used to relying on the tax paid on your savings and dividends to cover your Gift Aid donations.

If you no longer pay tax on them due to the personal savings allowance and dividend allowance, but continue to donate to charity under a Gift Aid declaration, the charity will still assume the donation has come from someone paying tax and claim an amount back from HMRC. You might then be faced with a bill from HMRC for the amount they have claimed.

You may wish to cancel your Gift Aid declaration. You can still donate to charity, but the charity cannot claim Gift Aid relief from HMRC. You should also bear this in mind when visiting attractions, which invite you to Gift Aid your ticket entry.

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Should I transfer savings or shares to my partner?

Members of a married couple or a civil partnership are taxed separately so each spouse or partner is potentially entitled to a personal allowance, a personal savings allowance, a dividend allowance, etc. In order to take best advantage of being taxed separately, it may be sensible to transfer savings or shares to your partner as this can save tax on the attributable interest or dividends if you are part of a couple where one person has spare capacity in their allowances or is in a lower tax band than the other.

However, if you transfer shares to your partner, this is a disposal for capital gains tax purposes. If you are not married or in a civil partnership when the shares are transferred, there may be capital gains tax to pay on the transfer. There will be no capital gains tax to pay if you are transferring (that is, gifting) a cash balance in pound sterling, irrespective of whether or not you are married or in a civil partnership.

If you have savings or shares held in joint names between you and your spouse or civil partner, by default 50% of the income (that is, the interest or the dividends) arising is treated as taxable on you and the other 50% is taxable on your spouse or civil partner. This is the case even if the underlying beneficial entitlement is unequal (for example, if only one spouse or civil partner funds the savings account or purchases the shares). However, you may both elect, on form 17, to be taxed in accordance with your respective beneficial interests instead, if these are unequal. The election is irrevocable and may only be backdated 60 days.

By contrast, note that joint owners of property (such as a joint bank account or jointly-held shares) who are not married or in a civil partnership, or in partnership, may agree any split of income between them. They would then be taxed accordingly. In this case, no form 17 is required.

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How do the personal savings allowance and dividend allowance work for Scottish and Welsh taxpayers in 2019/20?

If you live in Scotland and are a Scottish taxpayer, you can find out more about Scottish income tax in the tax basics section.

Scottish rates and thresholds apply to non-savings and non-dividend income only; a Scottish taxpayer pays income tax according to the UK rates and bands on their savings and dividend income.

Therefore, a Scottish taxpayer who has both earned income, such as employment salary, pension, profits from self-employment or rental profits, and taxable savings income, such as bank interest may have to consider both the UK rates and thresholds and the Scottish rates and thresholds in order to work out their income tax liability.

There is an example of how this may affect you if you are a Scottish taxpayer in the tax basics section.

In 2019/20, Welsh taxpayers pay the same income tax as taxpayers in England and Northern Ireland. For more information, see What is Welsh income tax?.

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How do the personal savings allowance and dividend allowance interact with the taxation of state pension lump sums?

When you take your state pension, you may be entitled to a state pension lump sum. If you are, when working out what rate of tax you should pay on any state pension lump sum, the special rates that are used to tax savings income and dividend income falling within the basic rate band – the starting rate for savings, personal savings allowance and dividend allowance are ignored. Therefore, if your total taxable income falls within the basic rate band (even if some of that income is taxed at 0% due to it being taxed at 0% savings and dividend rates), you will pay tax at 20% on your state pension lump sum.

Please see What tax do I pay on my state pension lump sum? for more information.

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HMRC have written to me about money I have invested offshore – what should I do?

You may have recently received a letter saying that HMRC’s information indicates you currently have or previously had offshore income or gains, and if you have additional tax to pay, to tell HMRC using the Worldwide Disclosure Facility. If this applies to you – read our news article What to do if HMRC ask you about money held overseas.

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Can you tell me about life insurance policies?

Life insurance is something you might come across if you are looking into tax-efficient savings and investment options. Some life insurance is designed to be an investment – a place to store and grow your money rather than just pay out when you die. The life insurance companies invest your money and when your investment matures, it will typically pay out a profit. Insurance policies are either qualifying or non-qualifying.

Qualifying policies are generally long-term policies where regular sums are paid in. There is typically no tax when a qualifying policy matures. Please see the website of the Money Advice Service for more information on qualifying policies.

Non-qualifying policies tend to be policies which are funded by a single premium rather than regular contributions. They are much more likely to give rise to tax consequences when they mature. Therefore, we concentrate on explaining how to work out if tax on non-qualifying policies due in our pensioners section.

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Examples

Henry – personal savings allowance

Henry earns £25,000 and has savings income of £600. He has to pay tax at 20% on £12,500 of his earnings (the amount left once his £12,500 personal allowance is used) however his savings income is tax free due to his £1,000 personal savings allowance.

If his savings income was £1,250 instead of £600, he would have 20% tax to pay on £250. As tax is no longer collected at source on interest, he will have to pay this £50 to HMRC another way – most likely by having his tax code adjusted.

John and James – adjusted net income

John (not a Scottish taxpayer) has total income of £50,001 in 2019/20. Of this, £1,000 is savings interest. Since his total income means that he is a higher rate taxpayer, he is entitled to a savings allowance of £500.

His savings income is taxed as follows:

£500 @ 0% = £0

£499 @ 20% = £99.80

£1 @ 40% = £0.40

Total tax on savings interest of £100.20

James (not a Scottish taxpayer) has total income of £50,000 in 2019/20. Of this, £1,000 is savings interest. Since his total income means that he is a basic rate taxpayer, he is entitled to a savings allowance of £1,000.

His savings income is taxed as follows:

£1,000 @ 0% = £0

Total tax on savings interest of £0

Thus, a £1 increase in income produces an additional tax liability of £100.20.

Eric – example combining starting rate for savings, personal savings allowance and dividend allowance

Eric (not a Scottish taxpayer) has earned income of £15,000, savings income of £4,000 and dividend income of £2,000. He has to pay tax at 20% on £2,500 of his earnings (the amount left once his £12,500 personal allowance is used). He has £2,500 of the starting rate for savings band available as his earned income is less than £17,500. So, the first £2,500 of his savings income is taxable at 0%. As his adjusted net income is £21,000, his personal savings allowance is £1,000. This means that he has a tax rate of 0% on a further £1,000 of his savings income. He must pay tax at 20% on the remaining £500 of his savings income, which is £100. He does not have to pay any tax on his dividend income as it falls within his dividend allowance of £2,000. As tax is no longer deducted at source from savings interest, Eric will have to pay the £100 tax to HMRC another way.

The above example can be represented as follows:

  Earned income (£) Savings income (£) Dividend income (£)
  15,000 4,000 2,000
Less: Personal Allowance (12,000)    
  2,500 4,000 2,000
Tax thereon: 2,500 @ 20% 500
Starting rate for savings 2,500 @ 0% 0
  5,000    
Personal savings allowance 1,000 @ 0% 0
  500 @ 20% 100
Dividend allowance 2,000 @ 0%  
Total     £600


If Eric has earned income of £15,000, savings income of £4,000 and dividend income of £32,000, he has to pay tax at 20% on £2,500 of his earnings (the amount left once his £12,500 personal allowance is used). He has £2,500 of the starting rate for savings band available as his earned income is less than £17,500. So, the first £2,500 of his savings income is taxable at 0%. As his adjusted net income is £51,000, his personal savings allowance is £500. This means that he has a tax rate of 0% on a further £500 of his savings income. He must pay tax at 20% on the remaining £1,000 of his savings income, since it falls into the basic rate band – £200 tax. He does not have to pay tax on £2,000 of his dividend income as it falls within his dividend allowance. He must pay tax at 7.5% on £29,000 (within the basic rate band) (£2,175 tax) and at 32.5% on £1,000 (within the higher rate band) (£325 tax) of his dividend income. As tax is no longer deducted at source from savings interest, Eric will have to pay the £200 tax on his savings interest and the £2,500 tax on his dividend income to HMRC another way.

Again, the above can be represented as follows:

  Earned income (£) Savings income (£) Dividend income (£)
  15,000 4,000 32,000
Less: Personal Allowance (12,000)    
  2,500 4,000 32,000
Tax thereon: 2,500 @ 20% 500
Starting rate for savings 2,500 @ 0% 0
  5,000    
Personal savings allowance 500 @ 0% 0
  1,000 @ 20% 200
Dividend allowance 2,000 @ 0%  
  29,000 @ 7.5% 2,175
  37,500    
  1,000 @ 32.5% 325
Total     £3,200


Liz – dividend allowance

Liz has a pension of £20,000 and receives dividends of £1,500. 

She has to pay tax at 20% on £7,500 of her pension (the amount left once her £12,500 personal allowance is used). However, her dividend income is tax free as it is less than the dividend allowance.

If Liz received dividends of £12,000 instead, the £2,000 dividend allowance would apply to some of her dividends leaving the remaining £10,000 to be taxed at 7.5%. Liz would have tax of £750 to pay on the dividends and would need to contact HMRC to arrange payment.  

Mr Chang – 5% rule

Mr Chang purchases an investment bond for £10,000. He takes annual withdrawals of 5% each year for six years, totalling £3,000. There is no tax on the withdrawals at the time he makes them. Several years later he cashes in the bond for £11,800. However the profit liable to tax is not £1,800 but £4,800 – because the £3,000 withdrawals are added into the gain calculation made when his policy ends.

If Mr Chang exceeded the 5% rule in one of the six tax years by taking out £1,000 instead of £500, then this ‘excess withdrawal’ of £500 would have been treated as taxable income on him for the year in question. If Mr Chang’s bond was an onshore bond, the £500 excess withdrawal would have carried a 20% unreclaimable tax credit, meaning he would only have had to pay tax on it if he was a higher or additional rate taxpayer. There would have been no such credit for an offshore bond.

Tom – 40% taxpayer – gains on insurance policies

Tom is a 40% taxpayer. His taxable income for 2019/20 is £52,000. He also makes two gains on life insurance policies he cashed in during the year. The Profitable Insurance Company has sent certificates to Tom showing what profits he made.

The gains amounted to £10,000 on each policy so Tom will need to pay extra tax of £4,000, worked out as £20,000 @ 20% (40% - 20%).

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Where can I find more information?

You can find out more about savings and tax in the HMRC savings manual.

For more information on how PPI pay-outs are treated for tax and tax credit purposes, see our news article Had a PPI claim and on a low income? If so, read this.

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