Understanding the Personal Savings Allowance

6th April 2016 saw the introduction of the Personal Savings Allowance (PSA), which enables most savers to earn up to £1,000 interest each year, tax-free. Previously, tax on interest was paid net of 20% and then subject to your marginal rate (0-45%).

Interest earned from bank and building society accounts, corporate bonds and government bonds, as well as peer-to-peer lending, is included in the new PSA and will be paid gross in future.

Please note: The PSA is separate from the Dividend Allowance.

Tax band* Personal Savings Allowance Any interest earned above the PSA will be taxed at:
Basic rate taxpayers £1,000 20%
Higher rate taxpayers £500 40%
Additional taxpayers £0 45%

Paying tax on interest over this amount

Any interest earned in excess of the PSA will be taxed at the marginal rate (20%, 40% and 45%).

Joint account holders

The PSA is for each individual. Joint account holders will have the interest split equally between them. This means that two basic rate tax payers could have a joint account paying up to £2,000 interest and not have any further tax liability.

If the account holders are in different tax bands, it gets slightly more complicated. For example, interest earned of £1,500 would incur a tax liability for a higher rate joint account holder as it would be split £750 each. The higher rate payer only has a PSA of £500 whereas the £1,000 PSA of the basic rate holder would leave £250 unused – or available for use in another account.

All a bit complicated?

Remember that an ISA wrapper negates the need for any of these considerations: 

  • ISAs remain completely tax free.
  • Less tax planning and administration is required if you invest inside an ISA.
  • Also, interest rates will go up again one day. While the PSA allowance looks big now, if interest rates increase to say 5%, the PSA allowance would be used up on just £20,000 of savings for a basic-rate taxpayer and £10,000 for a higher-rate taxpayer.

Read more about the benefits of the ISA