Income tax on savings: the new Personal Savings Allowance

The new Personal Savings Allowance makes it possible for savers to earn up to £1,000 of interest, tax-free, every year without needing to use tax shelters such as Cash ISAs.

Income tax and savings – the new Personal Savings Allowance

From April 2016 there is a new Personal Savings Allowance (PSA) that allows UK savers to earn up to £1,000 of savings interest every year without paying any Income Tax on it.

The level of PSA depends on your Income Tax band, as follows:

Tax band Personal Savings Allowance
Basic rate taxpayer Up to £1,000 savings interest tax-free
Higher rate taxpayer Up to £500 savings interest tax-free
Additional rate taxpayer £0 (no PSA)

Savings income now paid gross

As a result, savings accounts now pay gross interest, not net – they don't deduct Income Tax at source. Instead they report to the Inland Revenue how much they've paid to whom, so that your tax code can be changed if you end up owing Income Tax on interest in excess of your PSA.

Effect on the relevance of Cash ISAs

As a result of the introduction of the PSA, it's no longer the case that a Cash ISA generally beats non-ISA savings accounts because of the difference in net interest caused by the deduction of Income Tax.

With the threshold set at £1,000 for basic rate taxpayers, you'd need over £80,000 in savings in a best-buy 1.25% AER savings account before needing to look for Income Tax protection.

That said, there are reasons to still consider using your annual ISA allowance, because it is a permanent tax shelter that accumulates every year. In other words, should you one day you get to the point that you're earning interest above the PSA (for example, you are a higher-rate taxpayer with over £44,000 in a 1.15% AER account), under current rules you would not be able to transfer that lump sum into an ISA in one go.

Fortunately you don't have to adopt an ‘either-or’ approach. The PSA only applies to taxable savings. This means you can continue to subscribe to an ISA while also earning your PSA worth of interest in a non-ISA savings account.

Last updated: 07 July 2016