Paying tax and earning interest

When you’re looking to get the best returns you can from money you choose to hold as cash, rather than investments, it’s important to consider both sides of the coin: the tax you might pay and the interest you might receive... 

 

Taxation of cash investments

Remember, the new Personal Savings Allowance means that you can now receive tax-free interest on cash savings in an ordinary deposit account – not just an ISA.

At current interest rates, the Personal Savings Allowance stands at £1,000 a year for basic rate taxpayers and £500 a year for higher rate taxpayers. This will ensure that interest from most cash deposits is tax-free. 

At an interest rate of 1% – which is about the best currently available on an instant access savings account – a basic rate taxpayer could hold £100,000 on deposit without paying tax on the interest and a higher rate taxpayer £50,000.

The annual limits on tax-free interest are per person, so a couple using both their allowances would be able to hold substantial amounts of tax-efficient cash deposits between them. 

Cash held within an ISA is also tax-free and, with the annual ISA allowance rising to £20,000 per person from 6 April 2017, substantial cash savings can also be held in ISAs without paying tax on the interest.

Cash held within a pension deposit account also receives interest tax-free.

These generous rules mean that most people should not pay tax on interest received from cash deposits. 

 

Getting the best return on your money

As with any other financial product, it’s important to shop around for the best rate – in this case, the best rate of interest – for your cash. And, just as it can pay to switch utilities supplier from time to time, you should also be prepared to move your cash around as regularly as you need to. Always keep an eye out for the banks or building societies offering the best rates.

The best rate will depend upon how long you are prepared to lock your savings away. Fixed rate deposits over longer periods (of up to five years) generally offer the best rates of interest. However, if you want your savings back earlier, you may be prevented from accessing your money – or, more likely, an interest penalty will be applied which claws back some of the interest you expected to earn.

If your cash is to cover emergency needs, then an instant access account is probably the best bet. Although headline interest rates on these accounts are lower than fixed-rate accounts, they may still be better than a fixed-rate account if you unexpectedly need access to cash.    

Don’t assume that cash ISAs offer the best rates. Given that a normal deposit account can also receive interest tax-free by using your Personal Savings Allowance, it effectively amounts to the same thing as an ISA anyway. So, shop around for the best rates on both normal bank or building society deposit accounts and cash ISAs.

In fact, using a normal deposit account will leave your ISA allowance free for other investments such as stocks and shares.      

 

You might also be interested in…

> where to keep it

> when you should and shouldn’t use it

 

AR01837  12/2016

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