High-earners may pay too much tax on savings income

Rush to cash savings could leave many with an unwanted bill from HMRC.

Savers are being urged to check their tax code as you could end up paying more tax than necessary on cash savings.

The government launched the personal savings allowance (PSA) in 2015, letting basic rate taxpayers pay no tax on the first £1,000 of their total savings interest.

The allowance is £500 for higher-rate taxpayers, while those on the additional rate are excluded from the perk.

Savings rates have hit record lows in recent months so it is hard to earn £1,000 or even £500 interest without depositing huge sums.

But more money has been put into cash savings over the past year, which comparison website Savings Champion warns may create a tax issue for those who have put away large amounts.

At the time the allowance was introduced, the government estimated it would mean 95% of savers would no longer pay tax on their savings.

This meant tax was no longer deducted at source and savings interest is paid out gross.

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HM Revenue and Customs (HMRC) will instead alter your tax code if you go over the allowance so it can take the correct amount owed.

If you’re employed or get a pension, HMRC will change your tax code so you pay the tax automatically. Alternatively, a self-employed person would have to declare it through their self-assessment tax return.

To decide your tax code, HMRC will estimate how much interest you’ll get in the current year by looking at how much you got the previous year.

Savings Champion has warned that savers could be penalised using these calculations as interest on many products was higher last year.

Those with a 12-month bond maturing now could have been earning as much as 1.66% gross, Savings Champion said.

This means basic rate taxpayers and high earners with a deposit of more than £60,241 would breach the allowance by earning more than £1,000 interest.

But if they are reinvesting today, with the best one-year bond currently paying 0.65%, that £60,241 would earn just £392 – well below the PSA.

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Anna Bowes, co-founder of Savings Champion, said: “Interest rates have plummeted in 2020, which is likely to make a difference to savers, in particular those with large amounts held in cash.

“With such low interest rates, many may decide that cash is no longer the best place for their money – and therefore the amount they hold in cash and earning interest will fall.

“All these things could lead to a tax code that does not reflect your circumstances and therefore you could be paying too much tax.”

Tax codes are typically sent in February or March and Bowes says savers should check to ensure they don’t end up paying too much to HMRC.

Andrew Hagger, founder of personal finance website Moneycomms, says savers should consider tax-free products.

He adds: “It pays to consider diversifying so not to fall foul of taxation limits.

“That could involve using cash ISA allowances of perhaps investing in National Savings & Investments premium bonds or equity-based investments.”