The sharp rise in interest rates have left many borrowers feeling squeezed as mortgage payments become more expensive than they have been over the last few years. It is more important than ever to be smart with your savings.
There is a small silver lining for savers, as you can now fix into a cash deposit and receive an interest rate of over 4% for the year. On a £50,000 deposit, you could earn yourself another £2,000. An additional £2,000 per year could help offset the cost of increased utility bills this year. There are a few things to think about, so this article will help you to be smart with your savings.
Fixed Rate Deposits vs Cash ISAs
Currently the rates on offer are higher from a normal “unwrapped” cash account, (unwrapped meaning not inside an ISA, pension or other tax wrapper). The logical decision then would be to use a fixed rate deposit as opposed to a Cash ISA… or would it?
The tax conundrum on Fixed Rate Deposits
If you are a basic rate taxpayer, you can earn up to £1,000 per annum in interest* with no additional tax, £500 if you are a higher rate taxpayer and £0 if you are an additional rate taxpayer. In our above example, a higher rate taxpayer would need to pay tax of 40% on the £1,000 of interest mentioned above. Interest of £2,000 minus savings allowance of £1,000 x 40% = £400 in tax!
You could however opt to use your full ISA allowance in this tax year, (£20,000) and the remaining £30,000 could be placed within a fixed rate savings account.
*If you earn under a certain threshold, you may be entitled to even more interest tax free, for further information please visit Tax on savings interest: How much tax you pay – GOV.UK (www.gov.uk)
Should I just pick the account with the highest rate of interest?
You may be tempted to think that way, but lets consider the example above. We’ll assume for the purpose of this article that you are a 40% taxpayer (Also known as “higher rate”).
In this example there are two accounts on offer, a Cash ISA fixed for a year offering 3.70% in interest and a normal fixed rate deposit offering 4.35% for a year.
- £20,000 fixed for a year at 3.70% in an ISA = £740 in interest with no tax to pay.
- £30,000 fixed for a year at 4.35% (outside an ISA, therefore liable to tax) = £1,305 gross.
- £1,305 minus the savings allowance of £500 for a higher rate taxpayer, means you have to pay 40% tax on £805 = tax payable of £322. Total gross interest of £1,305 = £322 = £983 net of tax.
- £983 from the Fixed Rate plus + £740 from the ISA = £1,723
If we you put the whole £50,000 in at 4.35% your interest would be £2,175 for the year, minus £500 of personal savings allowance. You would then pay tax (£1,675 x 40% tax is a net payment of £1,005), when added to £500 this is £1,505.
So what worked out better? Even though our Cash ISA had a lower interest rate, your net payment was £1,723 whereas if you fixed the whole account outside of an ISA the net rate was £1,505, £218 less.
ISA or Fixed Rate Deposit?
There are a number of options to consider and the above doesn’t take into account your personal situation, there are a several other things you could do to help lower your tax burden.
Whilst quite a simple situation on face value, it can get a little nuanced, if you are confused we’d suggest you seek advice from an Independent financial adviser or your accountant.
How you might lower the tax burden on your savings
- If you have a partner, ensure you both make full use of your ISA allowances
- If you’ve already done the above, consider putting the savings deposit in the name of the partner with the lowest tax liability
- Consider making a pension contribution to move you from the higher rate threshold to the basic rate threshold, if possible and affordable.
- You could also make a charitable donation, achieving the same effect as the above
- If you are an additional rate taxpayer and your partner is not, you should try and ensure that you are not holding the cash deposits in your name, as you cannot receive any interest without paying tax
How to declare the interest to HMRC
For years our interest rates have been so low that unless you’ve got significant cash deposits you’ve likely never had a tax liability on savings. If you think you might do this year, the HMRC guide will explain how the tax position works. Tax on savings interest: How much tax you pay – GOV.UK (www.gov.uk)
Conclusion
So there you have it, a brief explanation of how to be smart with your savings, as with all things financial it can get a little confusing. If you would like to discuss any of the above with a local independent financial adviser in Rayleigh, then please get in touch.
Not local? We’re always happy to meet via video conferencing.
T: 01268 944122
E: p.denning@sterlingandlaw.com
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