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What are Personal Savings Allowances?

The personal savings allowance (PSA) will come into effect from the 6th of April 2016. Though the changes were mentioned a lot in the budget announcements many people still do not understand the implications of PSA and what it means for them as an investor.
It is really important to understand PSA as it is a huge change and has the potential to mean 95% of the population won't pay tax on their savings.

What is an PSA?

  • PSA affects the amount of tax you pay on your savings
  • If your are a basic rate tax payer your PSA is £1000. A basic rate tax payer pays 20% tax on their savings so you can earn £1000 in interest per financial year without paying tax on it. 
  • If you are a high rate tax payer your PSA is £500. A high rate tax payer pays 40% tax on their savings, meaning you can earn £500 in interest per financial year without paying tax on it.

How likely is it I will use the allowance?

Lets assume you have a savings account with an interest rate of  1.35% (this top of the market for easy access savers). You would need the following amounts to meet your thresholds. 

If you earn £17,000 or less per year then you will not pay any tax on savings income.

- Basic Rate Tax Band- £74074 
- High Rate Tax Band- £37,037

Those are some pretty large amounts you would need to have saved. But lets say you were more risky with your investments and had an account with a higher rate. 

- Basic Rate Tax Band- £29855 annual interest would be £1000.14
- High Rate Tax Band-  £14926 - annual interest would be £500.02

Thats still quite a lot to have saved and that is why the treasury estimate that for 95% they won't have to pay tax on their savings. 

What type of accounts are covered by PSA
  • Normal savings accounts (fixed and variable rates)
  • Current accounts (in banks, building societies and credit unions)
  • Investments with NS&I
  • P2P investments
  • interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts 
  • income from government or company bonds
  • most types of purchased life annuity payments
  • Investments in other currencies held in the UK

Not Covered (already tax free money)
  • Money invested in ISAs
  • Premium Bond winnings

How valuable are PSAs and what does it mean for ISAs?
- We don't know if future governments will retain PSAs. ISA have been around for much longer and therefore are less likely to be subject to a removal from the budget (though of course the annual allowance could very easily change).
- If we see high interest rates again then then £1000 will no longer feel like such a large amount.
- Also quite often ISAs have higher interest rates than traditional savings accounts (when compared for like for like features). Though this is not always the case and should be a consideration factor when considering which to choose.
- It is not clear how interest from bonds which accumulates over several years but is paid in one payment (rather than over several financial years) will be dealt with.

What do I have to do?
 To reap the rewards of the PSA you don't need to do anything. If you interest surpasses the the allowance you will pay tax. Banks will let HMRC know that you need a different tax code.

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  2. Thanks for the writeup, was planning on getting a PSA myself. Will be getting one sometime this weekend.