Over 2 million Britons are expected to pay tax on their savings this year. Why? Because interest rates have risen while the Personal Savings Allowance (PSA) has remained frozen. This has created a “Savings Tax Trap” that could result in millions receiving surprise tax bills from HMRC.
What Is this Savings Tax Trap?
Around 2.1 million Britons could be paying taxes on their savings this year. Just three years ago, this was 650,000. This is chiefly because the PSA has not been changed since it was introduced eight years ago, even though bank interest rates have gone up.
HMRC expects to collect £10.4 billion in tax from savings interest this year, up from £9.1 billion the previous year. According to the Bank of England (BOE), a record-breaking £11.7 billion was deposited into cash ISAs in April alone. However, millions are still at risk of unanticipated bills.
Under the PSA, the base rate taxpayers could earn £1,000 in interest without any tax being tax levied free. Meanwhile, higher-rate taxpayers could earn £500 tax free.
How to Get Around the Tax Trap?
People make the following mistakes that push them into this trap. Avoiding them can also help you avoid this tax trap.
Mistake 1: Choosing Fixed Rate Accounts
For tax purposes, the interest from a fixed-rate savings account that pays out at maturity is counted in one tax year, which could make you exceed your Personal Savings Allowance. But you can avoid this by choosing an account with monthly or annual interest payments, or by opting for a tax-free fixed-term ISA.
Mistake 2: Not Realising that Your Children’s Savings is Taxed Too
If a child earns £100 or more in interest on money gifted by parents, it is taxed as the parent's income, but using a Junior ISA or splitting the gifted money equally between parents can help avoid this tax.
Mistake 3: Pushed Into the Next Tax Bracket
The PSA is reduced or eliminated if someone moves into a higher income tax bracket. However, using an ISA, paying income into a pension to lower the tax bracket, or moving savings to a partner's account with a lower tax rate are ways to avoid this issue.
Conclusion
With more people at risk of paying tax on their savings, understanding these tax traps is more important than ever. If steps are not taken, these traps can lead to unexpected tax bills.
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