January, 2013

3 Ways To Pay Less Tax On Your Savings

Taxes are a fact of life. But, while you may not be able to avoid paying tax on your income, your shopping or your property, you may be able to earn tax-free interest on your savings.

If you’re a basic rate taxpayer, you’re probably paying 20 per cent tax on your savings interest. And, if you are a higher earner you may be losing 40 or 50 per cent of your savings returns to tax. If you want to ensure you’re getting the very best return on your savings it is vital that they are tax-efficient. Our guide gives you three great tips to paying less tax on your savings.

Maximise your ISA contributions

On 6 April 1999, the government introduced the Individual Savings Account (ISA). This type of account lets you save a certain amount of money each year and you’ll pay no tax on your returns.

In the 2012/13 tax year, the individual ISA allowance is £11,280. You can save up to £5,640 as cash and the remainder in stocks and shares. And, crucially, any money that you place in an ISA will earn gross rather than net interest. This ensures you don’t lose 20 per cent (or 40/50 per cent if you are a higher rate taxpayer) of your interest in tax.

From April 2013 the individual ISA limit rises to £5,760.

There are hundreds of ISAs available and, even if you don’t have the maximum to save, they are a great way of sheltering your savings from tax. Always consider using your ISA allowance before you put your savings elsewhere.

Register for gross interest if you’re not a taxpayer

If you’re not a UK taxpayer, you shouldn’t be paying tax on your savings interest. So, if you earn less than the threshold for paying tax – around £155 per week for under 65s – you should receive ‘gross’ rather than ‘net’ interest.

To do this, you need to speak to your bank or building society and complete a R85 form. This will register you for gross interest and ensure no tax is taken off before you receive your interest.

Take advantage of your partner or child’s tax status

If you have a partner than pays a lower rate of tax then you – perhaps they are a non-taxpayer – you could save your money in your partner’s name in order to benefit from paying less tax.

For example, you may be a higher-rate taxpayer and pay 40 per cent of your savings interest in tax. If your partner is a basic-rate taxpayer and only pays 20 per cent, you can save your money in your partner’s name and only pay 20 per cent tax.

Bear in mind that if you do this your savings will be in your partner’s sole name. Make sure you understand the implications of this before you decide on this course of action.

Another way to reduce the tax you pay on your savings is to open an account in your child’s name. If they earn less than the tax-free allowance then you can build up their savings without any tax being deducted. As above, your child will need to sign a R85 form (or you will need to sign it on their behalf).

You should remember that such an account has to be opened only with the express purpose of saving for your child. There are also restrictions on how much you can gift to your child without paying tax.

UK Income Tax in perspective

Governments past and present have frequently made much of the apparent low personal tax levels in the UK – at 20% or so our headline rate compares well with many other countries at first sight, particularly when you look over the Channel.  But is it really that low?  Or is it a political myth?

In his Autumn Statement on December 5th, George Osborne increased the personal allowance to £9449, almost hitting the £10k target adopted by the coalition in 2010.  But in increasing the personal allowance by £1340, what is given with one hand is more than taken away with the other.

Everyone gains – by £22 a month – and those who gain most pro-rata are indeed those on low incomes.  But they have also lost by the 1% cap on benefits, many of which, like Tax Credits and Housing Benefit, are paid to working families.  And of course inflation in essential goods and services like food and fuel is generally higher than headline inflation, so we live in an increasingly impoverished society where there is little hope for the low paid.

Let’s look at the total level of tax exerted on the workers – those strivers so praised by the government. But first, we need to take a trip in the history of taxation in the UK.

The straight forward system for income tax

Pay as you earn – PAYE – is a very neat idea, introduced in 1944.  You have a tax code such as 944L (the standard code from April 2013).  This means that the first £9449 that you earn in a year is free of tax.  Yup – just change the letter into a ‘9’ and that’s your tax free pay!  (The ‘official’ amount is £9445 but checking with the HMRC online tax calculator and others this is clearly wrong – it’s £9449!)  This code may change according to your circumstances – you may have essential work or other allowable expenses; perhaps you have underpaid tax in the previous year. There remains a married tax allowance for those born before 1935 but everyone else is taxed independently – in theory (although recent changes to Child Benefit is clearly an exception).  Or maybe you are over a certain age and the allowances are slightly more generous (although that is being withdrawn soon).

This tax free pay is divided equally according to how you are paid – monthly or weekly – so that for example the 944L code means the first £787.42p every month is not taxed.   But rather than deal with each month on its own, the allowance accumulates during the year as £787.42 in month 1 (April); £1574.83 in month 2 (May); £ 2362.25 in month 3 (June) and so until £9449.00 in month 12 (the following March).  Your earnings are also accumulated over the year in the same way and each month the accumulated tax owed is calculated, the tax already paid is subtracted and the result is deducted from your pay and sent to the revenue by your employers.

If your tax code is changed for any reason, the tax paid is automatically corrected and at the end of the year you have paid the right amount of tax.  If you enter higher rate, the same principle is applied so that if you slip back in earnings – or lose your job – the tax is always correct.  It is a very neat idea.

The complications

To begin with, there are a series of ‘clawbacks’ to be applied to your income tax, like student loan, tax credit and personal allowance for those earning over £100k. Another ‘clawback’ is the child benefit where one partner earns between £50k and £60k; this can lead to a marginal tax of over 100%.  Recently the Insititute of Fiscal Studies has also discovered this fact – although it has been misguidedly reported as ‘some having a marginal tax rate of 65%’.

Then, oh dear, there is National Insurance.  This was originally meant to pay for benefits and health but now is just another tax under a different name and is the second largest contributor to the Treasury after income tax.

NI applies to pay as and when it is received.  It is more complex because it depends on pension arrangements but in annualised terms it is 12% above £7592 a year and 2% above £42484 (2012/13 figures).  From your National Insurance, there are all sorts of fairly minor reductions – statutory sick pay, maternity pay, paternity pay, adoption pay and NI compensation on these plus NI holiday claimed.  It is an unholy mess really and almost impossible to check if your affairs are in the slightest bit awkward.

So while the headline basic tax rate is 20%, you actually pay up to 32% marginal tax and NI.  As your employer also pays up to 13.8%, the total deductions are up to 51.8% while you are on lower rate or 55.8% if you are on higher rate tax because the employer’s contribution is not limited!  And above £150k, the totals are 65.8% (down to 60.8% in 2013).

Is this low tax?