If your total taxable income is no more than £15,600 in 2015/16 any interest paid on your savings will be tax-free. But only if you fill in a form so that your bank or building society knows it should pay it gross. If you don't fill in the form R85 then 20% basic rate tax will be automatically deducted from your interest.
If your income before adding on your interest is less than £15,600 but your total income including interest is more than £15,600 then some of your interest will be tax-free. But the bank or building society will still deduct tax at 20p in the £. You will have to claim back the excess using another form called R40.
The interest on savings is taxed before it is paid. Basic rate tax is taken off automatically. So at the end of the year savings interest of 1% a year on £1000 is credited not as £10 but as a post-basic-rate tax amount of £8. Almost £2bn tax is automatically deducted from interest every year.
If your income is low enough not to pay tax (below £10,600 in 2015/16) then you can claim back the £2 using a form called R40. And can stop it being deducted in future by filling in another form called R85. But £200m a year is taken from non-taxpayers and never reclaimed because people do not bother to do so – or do not know they can.
From April 2015 on top of the £10,600 personal allowance another £5000 of savings interest will be tax-free (in fact taxed at 0%). But – and it is a big but – that only applies in full if the person has no other income on top of their personal allowance.
Think of savings interest as floating on top of other income from earnings or pensions. Like the cream on the milk. The first £10,600 of total income – cream and milk – is free of tax. The next £5000 is taxed at 20% if it is milk (earnings or pension) but at 0% if it is cream (interest). So someone with £10,600 of earnings or pension can have £5000 of income from savings on top of it tax-free. But if they have £11,600 earnings or pension then only £4000 savings interest is tax-free. And if they have £15,600 of earnings and pension then they get no tax-free savings.
For those it helps it can be valuable. Someone with state and private pensions which come to £10,600 pays no tax on those as they use up the personal tax-free allowance. And if they have £500,000 in a savings account earning 1% a year then all the £5000 interest will also be tax-free from April. That would be a saving of £712 compared to the current regime for these half-millionaires. Or as the Chancellor said in March when relaunching the new scheme “Putting money in the pockets of those who need it most.”
The cost of this concession to the Exchequer is expected to be more than £200m a year – or more if married couples move funds between them to take advantage of it.
To see if you can gain from the concession us the Government's free calculator. If you can then you should register to get your interest paid gross using Form R85. If you have paid tax on savings interest when you shouldn't, then claim it back to 2010/11 on Form R40. You will need one R40 for each tax year. To go back to 2010/11 you must claim before 6 April 2015. From that date the earliest you can go back is 2011/12. The rules in past years were different. If your total income was less than the personal allowance then you can reclaim all the tax deducted from your savings interest. And if your income was no more than around £2500 or so above the personal allowance you can claim back half the tax deducted. Full details in The Great Tax Take.
NB the new 65+ Guaranteed Growth Bond from National Savings & Investments always has basic rate tax deducted - you can't use Form R85 to stop it. But you can use Form R40 to get it back.
This blogpost is an expanded version of my Money Box newsletter for 6 March 2015. If you want future newsletters every Friday sign up here.
10 March 2015