Don't let tax eat up your savings

You may have thought that Gordon Brown scrapped the 10p rate of income tax in April 2008. And so he did for most income. But a remnant of it remains. Some savings income can still be taxed at 10% in some circumstances. Few people know about it and fewer still understand the rules. One of which is that the savings income is always taxed at 20% and the 10% has to be claimed back. A recent Freedom of Information request by Save Our Savers discovered that more than three million people should only pay 10% tax on their savings interest but very few of them claim back the overpaid tax.

No tax due
Although the 10p tax is a swindle, I will start with another that is just as big – people who should pay no tax at all on their savings interest. Joe is 70 so he can have £10,500 tax free income this year. His total income is just £8500 and he should pay no tax on any of it. But the interest on his savings will be taxed automatically at 20%. Joe has £10,000 in a savings account which pays 3% interest – £300 after one year. But a fifth of that – £60 – has been automatically deducted leaving him just £240. Don’t blame his building society – it has to deduct the 20% tax by law.

In these circumstances Joe should tell the building society to stop deducting tax in future. He does that by filling in form R85. He can get one from his building society or download and print it from the HMRC website hmrc.gov.uk/forms/r85.pdf . He fills it in and gives it to his building society. In future his interest will be paid with no tax deducted.

Second, Joe can reclaim tax wrongly deducted for four past years – it has recently been cut from six. Joe uses the table to check his personal tax allowance for past years. His income was less than the relevant figure in each year so he should have paid no tax on his savings. He can get the tax back for 2011/12 and previous years back to 2008/09. How to do that is explained below.

When the Revenue last counted, there was £200 million waiting to be reclaimed by people like Joe. Some of it could be yours.

Half tax due
Now it gets more complicated. If your income is above your personal tax allowance the income above that allowance is normally taxed at the basic rate of 20p in the pound. But if you have interest from savings it is possible that some it should be taxed at 10p in the pound.

That is because on top of your personal tax-free allowance there is a band of income that is taxed at 10% – but only if it is interest on savings (including taxable interest on National Savings products). And your savings interest is always taxed last. You can think of it as the cream floating on top of the milk of the rest of your income. So all your other income such as pensions and earnings are the milk and savings interest is the cream floating on the top. Only if some of your savings income floating on top is inside that savings rate band is that part taxed at 10%.

In the Table there is a line headed ‘10% savings rate band’. That shows the maximum amount on top of the personal tax-free allowance that can be taxed at 10%. Add up your other income that isn’t savings interest – any pension (including your state pension), earnings, self-employed profit, or rent (but not rent-a-room which is tax-free). It does not include dividend income.

If your other income above your personal allowance is as much or more than the 10% savings band then all your savings interest will be taxed at 20%. But if your other income on top of your personal allowance is less than the 10% savings band and you have some savings interest then the amount which sits within that band should only be taxed at 10%.

Examples
When you work out the amount of your interest it will already have had 20% tax deducted so you must gross it up to the original amount before tax was deducted. You do that by multiplying by 5 and dividing by 4. So if you got £1000 net income you count that as £1000x5/4 = £1250.

In 2011/12 John was 70. He had £11,000 from his state and works pension and he got £2000 net interest on his savings. He grosses that up to £2000x5/4 = £2500. In that year his personal tax-free allowance was £9940. So the first £9940 of his pensions was tax-free leaving £11000-£9940=£1060 to be taxed at 20%. Only the savings sitting on top of that and within the savings tax band is taxed at 10%. That £1060 uses up some of the £2560 savings tax band leaving £1500 of his savings income which should be taxed at 10%.  The other £1000 of savings income on top of that is taxed at 20%. His building society has deducted 20% off it all which is £500. But he should only have paid £350. So he is due a refund of £150.

Jean is 63 in 2012/13 with an income of £10,500 from a state pension of £7500 and interest from savings of £3000. Her personal allowance this year is £8105 so all her state pension is tax free and so is £8105-£7500=£605 of her interest. The balance of her interest is £2395. As this is less than the £2710 savings tax band it should be taxed at 10% which is £239.50. Her bank will deduct 20% from all her £3000 interest which is £600. She should pay £239.50 and must claim back the £361.50 after April next year.

All this is very complicated. But if you have savings interest. And your total income is less than your personal allowance plus the savings rate band then you are paying too much tax on your savings interest.

Reclaiming over-paid tax
If you think you may have paid too much tax last tax year or in any tax year back to 2008/09 you can try to claim it back now. You have to use a form called R40. You can download this form from HMRC http://www.hmrc.gov.uk/forms/r40.pdf . Print off one copy for every tax year you are claiming for. Send them to your own tax office or to Leicester & Northants (Claims), Saxon House, 1 Causeway Lane, Leicester, LE1 4AA.

Remember that husbands and wives are taxed separately. If you are married each spouse should work out their own figures. If money is in a joint account count half the interest each.

Higher incomes
The figures in this article assume your income is below the level to pay higher rate tax of 40% - £42,475 this tax year.

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TABLE

NB if your income is above £25,400 in 2012/13 your allowance will be lower

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More information
Save Our Savers campaigning group saveoursavers.co.uk
HM Revenue & Customs hmrc.gov.uk/taxback and examples of how the 10% tax band works hmrc.gov.uk/tdsi/ten-per-cent-guidance.htm
Tax Help for Older People gives free advice to pensioners on limited incomes taxvol.org.uk

e-mail Paul Lewis on paul@paullewis.co.uk