Savings and tax
Other tax issues
In this section we look in detail at common types of savings income, including bank and building society interest and dividends. 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 so that they can use your money to fund loans for other people.
Interest counts as income for tax purposes according to the date when 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.
In 2018/19, 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 personal savings allowance 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 2018/19, 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 the What tax rates apply to me? page 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 credits purposes.
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 £16,850 (for example, from wages, profits, pensions and savings – not including dividends) will pay no tax on their bank or building society interest in 2018/19, even without the PSA. The £16,850 figure can be higher if you get blind person’s allowance, marriage allowance or married couple’s allowance.
For an example of how the 0% 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 later in this section.
You can find a basic government factsheet on the personal savings allowance on the GOV.UK website.
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.
In 2018/19, most people with bank and building society interest will not have to pay tax on their savings income due to the PSA. So banks and building societies will 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 piece ‘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.
How much will my personal savings allowance be?
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.
- If your adjusted net income is up to £46,350, you will be entitled to £1,000 of tax-free savings.
- If your adjusted net income is between £46,351 and £150,000, you will be entitled to £500.
- If your adjusted net income is over £150,000, you will not be entitled to any PSA.
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 the GOV.UK website.
What other types of savings income does the PSA apply to?
As well as interest on bank and building society accounts, the PSA applies to other types of savings income:
- 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?.
Please note that the definition of savings income for the purposes of the PSA does not include all types of taxable savings income. If you are unsure as to the extent to which your savings income is taxable, you may need to seek professional advice. You can find an adviser on the Chartered Institute of Taxation website.
My bank account pays ‘rewards’ – does the PSA 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 0% 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 spend, which are 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;
- 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:
- If the reward takes the form of interest (i.e. 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.
- 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 0% 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, e.g. via a PAYE coding adjustment or through your tax return.
- 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 0% starting rate for savings). If you are a basic or higher-rate taxpayer you would need to pay any tax due to HMRC, e.g. via a PAYE coding adjustment or through your tax return.
If you have a cash Individual Savings Account (ISA), the interest you get is tax free anyway. 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.
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 direct 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 starting rate for savings band, 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).
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 2018/19 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.
A report by LITRG volunteer, Kelly Sizer, ‘The complexities of government-incentivised savings schemes for people on low incomes (October 2017)’ 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 news item 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.
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 don’t exceed the annual Junior ISA allowance (£4,260 for 2018/19).
Since December 2015, Help to Buy ISAs have been available. 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 2018/19 tax year, you can save an initial deposit of up to £1,200 and up to £200 a 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. In 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, not an ISA as such, but a government-incentivised savings scheme, Help-to-Save, is introduced from April 2018 and is aimed at supporting people on low incomes to build up their savings. Over 4 years, regular savers can deposit up to £50 a month and could 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 specific website guidance.
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.
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.
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 income.
The availability of a 0% dividend allowance means that in 2018/19, 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 2018/19, 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 the What tax rates apply to me? section of our website 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.
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.
Basic rate taxpayers with dividend income above the £2,000 allowance could be worse off. This is because dividends above the £2,000 allowance but still in the basic rate tax band (up to £46,350 for 2018/19) are charged at 7.5%. This represents a tax rise – under the old system basic rate taxpayers had no further tax liability on dividends received.
For a basic example of how this works, see Liz.
Please note that if you have dividend income of more than £2,000 but your total income is less than £11,850 – your income is covered by your personal allowance anyway.
If your dividend income is received through an ISA, it remains tax-free.
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 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).
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.
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.
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.
You should note that where property or assets are held in joint names, any income generated from it is generally treated as being owned equally for income tax purposes. So, it may be an idea to have a joint bank or building society account because even if the underlying savings belong to you and your spouse or partner in unequal shares, HMRC will normally tax the interest income as being received equally by you and your spouse or civil partner.
How do the personal savings allowance and dividend allowance work for Scottish taxpayers in 2018/19?
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.
So 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.
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 0% starting rate for savings, savings and dividend nil rates (personal savings and dividend allowances), are ignored. So 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 special savings and dividend rates), you will pay tax at 20% on your state pension lump sum.
You can find more information about the taxation of state pension lump sums on our website.
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 item What to do if HMRC ask you about money held overseas.
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 is due in the remainder of this section.
The first thing to say is that the taxation of investment bonds can be very complicated and while we give some general information below, you should ask your financial adviser or a specialist tax adviser if you are unsure about your position. You can find an adviser on the Chartered Institute of Taxation website.
You make a profit or gain on the policy if the amount you get when you cash it in is more than the amount of the premiums you have paid.
Each year you can withdraw tax free up to 5% of the amount you originally invested. If you do not withdraw your 5% in one year you can carry it forward. This means that in the second insurance year, if you have not made a withdrawal in the first insurance year, you can withdraw up to 10% of the premium paid tax-free. However these amounts will be taken into account when you cash in the policy and will make the end profit higher, so it is worth remembering this if you do not need to take out the money each year.
See the example of Mr Chang for more information on the 5% rule.
When you cash in the policy, any profit you make is free of capital gains tax. You can think of it instead as an 'income tax gain'. This is not the same type of gain that you make when you sell or give away an asset.
If you are not a higher rate taxpayer, for example you are a non-taxpayer or are a 20% basic rate taxpayer and you have an onshore bond, you have no more tax to pay on the profit or gain you make. This is because the profit that you make on the policy is treated as having already suffered tax at 20%. Offshore bonds do not carry the 20% ‘credit’.
Please note that it is not possible to get any of this tax back, even though the personal savings allowance (PSA) will see greater numbers of policyholders with no tax to pay on life insurance gains. This is because the 20% deduction does not equate to a ‘withholding tax’ per se. Rather, the arrangements reflect the unique regime applying to life insurance companies, under which part of the corporation tax paid is regarded as relating to investment gains made in the company for the benefit of policyholders. The rules implementing the PSA will however, ensure that the allowance is applied to other types of savings income before life insurance gains. This will minimise situations in which no repayment is available in respect of non-taxable gains treated as taxed at the basic rate.
If you are a higher rate (40% in 2018/19) or additional rate (45% in 2018/19) taxpayer, you will have to pay extra tax. The profit on the policy is treated as the very top slice of your income. If you are a higher rate taxpayer, you will pay tax at 40% less the 20% tax that you are treated as having already paid.
Look at the example Tom to see how to work out the tax liability of a higher rate taxpayer on an insurance policy gain.
If the profit pushes a basic rate taxpayer into higher rate or higher rate taxpayer into the additional rate, there is a special relief available, called 'top slicing relief'. Top slicing relief may assist in reducing the amount of tax charged by applying a spreading mechanism. This recognises the fact that although the gains have probably arisen over the period of investment they are assessed in a single year which can cause disproportionately higher liability.
Consider, for example, someone who invested £10,000 in a bond and left it for 10 years, during which time it doubled in value. If the entire profit of £10,000 was assessed in a single year, it might attract a higher amount of tax than if the returns were assessed annually. With top slicing relief applied, the gain of £10,000 would be divided by the number of complete years the bond had been held, in this case 10, creating an average gain of £1,000. The top sliced gain is added to the investor’s taxable income in the year the bond is cashed in and the amount of tax due on the top sliced gain is calculated. This is then multiplied by the number of years the bond was held to find the tax due on the total gain. So, top slicing relief has the effect of calculating any tax that may be payable at the investor’s marginal rate of tax on the average annual gain.
You need to show the profits on your tax return if you need to complete one and you will receive details of the amount to be included from your insurance company. If you do not receive a certificate you should contact the company and ask for one.
You should bear in mind that any life insurance profits count as your income when working out what married couples allowance (MCA) you may be entitled to. Even though you may still be a 20% taxpayer, the loss of MCA means you will effectively be paying more tax. You can see more about MCA restrictions in the pensioners section.
Henry earns £25,000, and has savings income of £600. He has to pay tax at 20% on £13,150 of his earnings (the amount left once his £11,850 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 – probably by having his tax code adjusted.
John (not a Scottish taxpayer) has total income of £46,351 in 2018/19. 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 £46,350 in 2018/19. 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 (not a Scottish taxpayer) has earned income of £15,000, savings income of £3,000 and dividend income of £2,000. He has to pay tax at 20% on £3,150 of his earnings (the amount left once his £11,850 personal allowance is used). He has £1,850 of the 0% starting rate for savings band available as his earned income is less than £16,850. So, the first £1,850 of his savings income is taxable at 0%. As his adjusted net income is £20,000, 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 £150 of his savings income – £30 tax. 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 £30 tax to HMRC another way.
If Eric has earned income of £15,000, savings income of £3,000 and dividend income of £30,000, he has to pay tax at 20% on £3,150 of his earnings (the amount left once his £11,850 personal allowance is used). He has £1,850 of the 0% starting rate for savings band available as his earned income is less than £16,850. So, the first £1,850 of his savings income is taxable at 0%. As his adjusted net income is £48,000, 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 £650 of his savings income, since it falls into the basic rate band – £130 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 £26,350 (within the basic rate band) (£1,976.25 tax) and at 32.5% on £1,650 (within the higher rate band) (£536.25 tax) of his dividend income. As tax is no longer deducted at source from savings interest, Eric will have to pay the £130 tax on his savings interest and the £2,512.50 tax on his dividend income to HMRC another way.
Liz has a pension of £20,000 and receives dividends of £1,500.
She has to pay tax at 20% on £8,150 of her pension (the amount left once her £11,850 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.
Had they been received in the 2015/16 tax year, they would have essentially been tax free.
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 is a 40% taxpayer. His taxable income for 2018/19 is £49,000. 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%).
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 piece: Had a PPI claim and on a low income? If so, read this.