Savings experts warn that as interest rates rise, millions of people are at risk of breaching the Personal Savings Allowance (PSA). Once they do, they will start paying income tax on interest from their deposit accounts.
Today, more than 9 out of 10 savers pay zero tax on their liquid savings, thanks to the PSA.
Under the allowance, introduced by former Chancellor George Osborne in April 2016, basic rate taxpayers can earn £1,000 in interest a year before paying income tax.
Higher rate taxpayers of 40% can earn £500 a year in savings interest before the tax kicks in.
A basic rate taxpayer earning 1.5% a year on a non-Isa savings account currently needs a significant savings of £67,000 before breaching the PSA and paying tax.
Most don’t come close as a result.
Higher rate taxpayers would need £33,500 in savings earning 1.5% interest before they exceed their PSA.
Yet, as the Bank of England raises base rates and interest paid on savings rises, others will be caught off guard.
As a result, savers could find themselves paying significantly more tax to HM Revenue & Customs.
Aldermore Bank is now paying 3% a year on its two-year fixed-rate bond, on sums between £1,000 and £1million.
A base rate taxpayer earning 3% would be in breach of the PSA if they only had £33,300 in savings.
A higher rate taxpayer would only need £16,650 before they start paying 40% income tax on their savings interest, says Laura Suter, personal finance manager at investment platform AJ Bell. “As a result, an increasing number of people could find themselves hit with a shock tax bill.”
There is another danger.
Thanks to former Chancellor Rishi Sunak’s decision to freeze the income tax threshold for five years, several million people will be moved from the base tax bracket to the top 40%.
Some higher rate taxpayers may soon pay income tax at the additional rate of 45%. At that point, they will completely lose their PSA.
Suter said: “A lot of people will be caught off guard because they slipped into the next tax bracket and didn’t realize their personal savings allowance would be reduced accordingly.”
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The government expects a 44% increase in the number of people paying higher rate taxes and a 50% increase in those receiving the additional rate bracket.
“A lot of people won’t be aware of the danger until they’re landed with a tax bill,” Suter added.
The Bank of England’s rate-setting committee has raised base rates five times in a row since December, from 0.1% to 1.25% today.
The committee is expected to rise 0.5% at its next meeting on August 4, bringing the base rate to 1.75%.
It could exceed 2% by the end of the year, driving up savings rates.
A base rate taxpayer earning 5% interest would hit the PSA with just £20,000 in savings, falling to £10,000 for a higher rate taxpayer.
Suter said those at risk could take steps to limit the damage by making full use of their tax-free Isa allowance.
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Cash Isas dipped in popularity after the introduction of PSA because rates on non-ISA accounts were often more attractive, Suter said.
That could now change, as non-Isa savers face a ‘triple whammy’ with cash interest rates rising, more people pushed into higher tax brackets and the PSA frozen. for six years.
“All of these factors mean that a lot of people are going to be landed with tax bills for their savings, most likely for the first time.”
Every UK adult can put up to £20,000 in a cash Isa and pay no tax on the money for life. “That means a couple can shelter £40,000 between them,” Sutter added.
Victoria Scholar, chief investment officer at Interactive Investor, warned: “Your long-term investments could work harder in a Stocks and Shares Isa.”
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