Your IndustryFeb 10 2016

Prepare for new personal savings allowance

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It was announced during the 2015 spring Budget that a personal savings allowance will be introduced from April 2016.

This is especially good news for those on lower incomes. In effect, this is a tax-free personal savings allowance abolishing tax on savings for 95 per cent of savers. The amount allowable depends upon the rate of tax you pay on your income. If an individual is a basic-rate taxpayer, they will have an allowance of £1,000 to use against their savings income, and if they are a higher-rate taxpayer, they will have £500 towards their savings income. Additional-rate taxpayers will not benefit from these new changes.

The introduction of this allowance, along with the zero per cent starting rate up to £5,000 that was introduced last year, will provide a large reduction in tax due for those on a lower income. For example, in the current tax year 2015/16, Mr Jones had pension income of £11,250 and gross interest of £6,200, so the tax due would be as follows:

PensionGross interestTotal
£11,250£6,200£17,450
Personal Allowance(£10,600)(£10,600)
Taxable income£6,506£6,200£6,850

The first step is to consider the use of the zero per cent starting rate up to £5,000. Mr Jones’s saving income is £6,200 and his taxable pension income after personal allowance is £650. We must first reduce the £5,000 band by the taxable pension income, that is, £5,000 minus £650 = £4,350.

The final tax liability is then computed as follows:

£650 at 20 per cent =130

£4,350 at 0 per cent = 0

£1,850 at 20 per cent = 370

£6,850 £500

Looking now at tax year 2016/17, let us assume Mr Jones has identical income to the previous tax year:

PensionGross interestTotal
Income£11,250£6,200£17,450
Personal Allowance(£10,800)(£1,000)(£11,800)
Taxable Income£450£5,200£5,650

As Mr Jones is a basic-rate taxpayer, he will now be able to take advantage of the new personal savings allowance. It is also important to remember that the personal allowance for 2016/17 will increase from £10,600 to £10,800.

The £5,000 starting band is still reduced by the pensions income left after personal allowances: £5,000 minus £450 = £4,550. This leaves £650 to be taxed at the basic rate (£5,200 minus £4,550 = £650).

£450 at 20 per cent = £90

£4,550 at 0 per cent = 0

£650 at 20 per cent = 130

£5,650 £220

As you can see, Mr Jones’s income is the same as the previous year. With the new changes effective from April 2016, his tax is reduced by £280.

We have assumed in the examples above that the savings income has been received gross. During the Budget, it was announced that interest from banks and building societies would no longer have tax deducted at source. This means that the R85 form will be abolished. For the majority of people, the interest they receive will fall within the £1,000 and £500 allowance.

However, if this allowance is exceeded then there would be tax due on the amount over. This tax is expected to be collected through an automated coding out of savings income that would be taxable through the Pay As You Earn (PAYE) System. This will be done through information provided to HMRC by the account providers. The exact mechanism is unknown, but there will be further details for customers prior to any tax becoming due.

Ben Chaplin is managing director of Taxwise