Do You Need to Pay Tax on Your Savings and Investment Income?

Savings and investments can be ample additional sources of income. However, such income sources are not completely exempt from tax. Depending on the products you are getting paid in interest or dividends, you will still have to report and settle your dues to HMRC.

This guide will show you what type of savings and investments income you need to pay tax on, how much you need to pay, and the process of reporting to HMRC.

Savings Income Tax

What is considered savings income is the money you make through interest. Interest is generally earned through the following:

  • Bank or building society accounts
  • National Savings & Investments (NS&I) products
  • Corporate bonds and gilts
  • Permanent interest-bearing shares (PIBS)
  • Local authority investments
  • Unit trusts or open-ended investment companies (OEICs)
  • Voluntary annuities

You can use your allowances on the interest you earn before you have to start paying tax.

Personal Allowance

Your Personal Allowance is part of your income that you do not have to pay any tax on. The standard Personal Allowance is £12,500. It can be bigger if you claim Marriage Allowance and Blind Person’s Allowance. It gets smaller the higher your income starting from £100,000.

If you have not used your Personal Allowance on your wages, pension, or other income, you can use it on the interest you earn.

Personal Savings Allowance

Depending on where you fall under the Income Tax band, you have a certain amount of income called your Personal Savings Allowance that you do not have to pay any tax on.

Your Personal Savings Allowance is as follows:

  • Basic Rate — £1,000
  • Higher Rate — £500
  • Additional Rate — £0

You can also use your Personal Savings Allowance to avoid having to pay taxes on the interest you earn.

Starting Rate for Savings

Lastly, you have a starting rate for savings that lets you earn up to a certain amount of interest without having to pay tax depending on how much you earn from other income such as your wages or pension.

You have a maximum starting rate for savings of £5,000 if your other income is less than £17,500. This is reduced by £1 for every £1 of other income above your Personal Allowance.

For example: You earn £15,000 in wages and £250 in savings. You subtract your Personal Allowance of £12,500 from £15,000. The remaining £2,500 is then used to subtract from the maximum starting saving rate of £5,000, making your starting saving rate £2,500.

Because of your £2,500 starting saving rate, you do not have to pay taxes on the £250 interest you earned.

You can use your allowances on interest earned from the following:

  • Bank or building society accounts
  • Savings and credit union accounts
  • Unit trusts, investment trusts, and OEICs
  • Peer-to-peer lending
  • Trust funds
  • Payment Protection Insurance (PPI)
  • Government or company bonds
  • Life annuity payments
  • Some life insurance products

How Much Tax to Pay on Savings Income

Once you have applied all your allowances to earn tax-free interest, you will have to start paying tax on savings income. Fortunately, how much you pay is as simple as paying your Income Tax rate. This is automatically paid if you are employed or get a pension, as HMRC changes your tax code. HMRC determines the tax code for you based on an estimate of how much interest you will earn in the current year, which is based on how much you earned in the previous year.

If you earn over £10,000 in savings and investments income, you need to file a Self Assessment tax return, where you have to report interest earned on savings.

Your bank or building society will tell HMRC the interest you’ve earned at the end of the year if you are not employed, do not get a pension, or you don’t need to report a Self Assessment. HMRC then tells you if you need to pay tax and how much.

Tax-Free Savings

There are types of interest earned from savings products that you don’t have to pay any tax at all, no matter your income or how much savings interest you earn.

These include interest earned from Individual Savings Accounts (ISAs) and NS&I products like index-linked savings certificates.

Reclaiming Paid Tax on Interest

If you believe you’ve paid more tax on your interest than you should have, you can reclaim it by completing form R40 and sending it to HMRC. You will likely get your tax back in six weeks. This can only be done within four years of the end of the relevant tax year.

Investment Income Tax

There are two types of investment income that can be taxed: share-based investments and life insurance investments.

Dividend Income

Share-based investments let you earn dividend income, which includes investments made in the following:

  • Owned shares in companies
  • Investment trusts
  • Unit trusts and OEICs

You have a Dividend Allowance of £2,000 for the 2019-20 tax year. You only have to start paying tax on dividends above that threshold. The tax rate depends on where you are in the Income Tax band.

Income Tax Band and Corresponding Dividend Tax Rate

  • Basic rate — 7.5%
  • Higher rate — 32.5%
  • Additional rate — 38.1%

Dividends earned from a pension or ISA are not taxed.

If you are within the basic rate income tax band and make more than £2,000 in dividends, you need to file a Self Assessment tax return.

Life Insurance Investments

When you make an investment in a life insurance policy, your income will be automatically deducted at the basic tax rate of 20%. Taxes on top of that depends on where you fall in the Income Tax band.

  • Basic rate — No extra tax
  • Higher rate — 20%
  • Additional rate — 25%

You also don’t have to pay extra tax if you earn less than £12,500.

You can avoid paying extra tax even if you are a higher or additional rate taxpayer, if your insurance policy is qualifying.

Reporting Investment Income to HMRC

When you have investment income that can be taxed, you need to report this to HMRC. It used to be that investment income automatically gets deducted at the basic tax rate from the source. This is not the case anymore for some investment income, so you are obliged to let HMRC know about all your investment income.

Prepare your National Insurance number and call HMRC. Their number is 0300 200 3300. Inform them of your interest and dividends before tax. HMRC will give you a new tax code to deduct the proper amount of tax from your investment income.

Secure Your Savings and Investments

Earning interest and investment income displays foresight and prudence in wealth management. Don’t get tripped up on taxes. Pay what you’re due. You want to be able to spend your savings and dividends on life’s fineries, not on fines.

If you want to make sure that you’re paying the right taxes on your savings and investment income, our professional accountants are ready to help. Get in touch with us today.