Millions of savers face paying income tax on their cash deposits once again as savings rates rise.
Almost nine in 10 have not had to worry about paying tax on their bank and building society accounts for years, thanks to a tax break introduced in 2016 called the personal savings allowance (PSA).
The PSA was introduced in April 2016 and allows basic-rate 20 percent taxpayers to earn £1,000 savings interest a year before paying income tax.
Higher-rate 40 percent taxpayers can earn £500 a year before paying tax, but additional rate 45 percent taxpayers are taxed on the first penny.
When savings rates were much lower than they are today, only the very wealthy with large deposits risked an income tax bill.
A basic-rate taxpayer earning interest of just one percent needs more than £100,000 in savings to breach the PSA, while a higher rate taxpayer needs £50,000.
These are large sums to leave in cash so in practice most did not have to worry about a bill.
Many chose to save in standard savings accounts rather than a tax-free cash Isa, because they typically pay higher rates.
That was fine while the interest from standard savings accounts rarely exceeded the PSA, but that is now changing fast.
Savers are finally earning decent levels of interest but their joy may be short-lived as HMRC is preparing to swoop with shock tax bills.
At that rate of return, basic rate taxpayer who took out Investec’s best buy three-year fixed rate bond which pays 4.5 percent will breach the PSA with just £22,500 of savings. This falls to £11,200 for those on higher rate tax.
Andrew Hagger, savings expert at MoneyComms, said the tax trap could tighten further. “The Bank of England is expected to hike base rates agains this year and if savings rates follow even more could be pushed into HMRC’s tax trap.”
One hugely popular type of savings account could cause particular problems, fixed rate bonds running for two, three, four or five years.
Hagger said: “Many fixed-rate bonds pay all of your interest as a single lump sum at maturity. If you get up to five years of savings interest at once, you are far more likely to breach the PSA.”
Express reader Sandra Wrench, 70, from Bedford, discovered this to her cost after taking out a five-year fixed rate bond with the Punjab Bank in December 2012. “I received interest of just over £2,518.89 in one go in 2017, as it was not averaged out over the five-year term.
“I also received £3.60 from Barclays and £88.83 from TSB that year, which put me over the PSA so that I was taxed on all my interest above £1,000. So there is no escaping HMRC.”
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Hagger said savers should always check when interest is paid before taking out a fixed-rate bond. “Providers including Charter Savings Bank, Ford Money and Shawbrook Bank give you the option of receiving your interest monthly instead of at maturity.”
Another risk is that more savers will get pushed into a higher tax band, thanks to Chancellor Jeremy Hunt’s move to freeze income tax thresholds until 2028.
A basic rate taxpayer who is pushed into the 40 percent tax band will see their PSA halved from £1,000 to £500, and may not realise the danger until too late.
Tax rules on savings are complicated, adding to the danger. Savers whose total annual income falls below the £12,570 personal allowance will not pay any tax on savings interest.
They can earn a further £5,000 tax-free under the zero percent starting rate of savings, lifting that to £17,570, with the £1,000 PSA on top.
After that, HMRC will want its share.
Maybe the cash Isa is ready for a comeback.