Whilst the rise in interest rates has been really good news for savers, the additional interest could give an unexpected tax liability.
Individuals who pay Income Tax at the basic rate have a savings allowance of £1,000. Whilst interest rates have been low, relatively few basic rate taxpayers have earned interest in excess of this. However, rising interest rates mean far more individuals will have to pay Income Tax on their savings.
A further problem is that whilst people’s incomes have been rising, tax thresholds have not, and this fiscal drag has resulted in many more taxpayers paying tax at the higher rate of 40%, meaning they have a reduced savings allowance of just £500.
Additional rate taxpayers (those with total income in excess of £125,140) have no savings allowance at all, and must pay tax on all their savings income.
If you are a parent who has put money into your child's savings account, please be aware of rules which stop you using your child’s tax-free allowances to reduce your own tax bill. With increasing interest rates the interest on these savings could exceed £100 a year (or £200 if both parents give money). This would mean all of the interest (not just the amount over £100) will be taxed as if it were your own. Interest less than £100 is not caught by this rule. The £100 limit does not apply to interest on funds gifted from other family members, such as grandparents, or friends.
Having the income chargeable on you could push you over your personal savings allowance, generating an unforeseen tax charge.
You might want to consider moving the funds to tax free savings, such as a Junior ISA, with a £9,000 investment limit in the 2023-24 tax year.
Dividends on investments
The dividend tax credit was abolished back in 2016 at which time a dividend allowance of £5,000 was introduced, which was sufficient to cover dividends received by most private investors. Over the years the allowance has been cut to its current level of £1,000 and this is to be further reduced to just £500 from April 2024. This is going to mean many more investors will have tax to pay on their dividends.
Capital gains tax threshold
The annual exempt amount for capital gains tax was drastically reduced from £12,300 in the previous tax year to £6,000 in 2023-24. A further cut to just £3,000 has been announced for 2024-25. This will mean that not only can investors expect more tax on investment income, there is a far greater chance of investment portfolios generating gains in excess of the annual exempt amount.
Now is a good time to check over your savings and investments to make sure they are as tax efficient as they can be. We would always recommend speaking to a suitably qualified financial adviser before taking investment decisions.
If you want to talk about tax on your savings and investments, please get in touch. We are here to help.