As returns on savings accounts rapidly fade away, paying tax on the dwindling interest will become a bigger burden for people relying on cash for their income.
Many savers suffer from double taxation as they are taxed on money they earn and then again on interest paid when they deposit it with a bank or building society.
So, with many savings accounts now paying less than 1 per cent interest, handing over 20 per cent – or 40 per cent for higher earners – in tax is far from attractive.
But with few other options for risk-free profits, it is therefore more important than ever that savers maximise their returns.
“Savers face uncertain times,” said Leonie Kerswill, tax partner at PricewaterhouseCoopers. “Many taxpayers want to save against even rainier days and will want to do so in savings accounts, even with interest rates as low as they are.”
The threat that many people – notably pensioners who have little other income – could receive close to zero interest from their savings has prompted the government and the opposition to look at helping savers.
The Conservatives have pledged to abolish basic rate tax on savings and to raise the tax-free band for those aged 65 and over. Pensioners can currently earn £9,030 (or £9,180 for those over 75) before they start paying tax. The Conservatives propose to raise this by £2,000.
The government is more likely to focus on stimulating savings through tax-efficient individual savings accounts (Isas). Alistair Darling, the chancellor, this week said he wanted to encourage saving, but felt the opposition’s proposal to raise the personal allowance would be of limited help as 60 per cent of pensioners already pay no tax. He said he would continue to look at how to make Isas attractive.
Industry groups including the Association of British Insurers (ABI) and Building Societies Association (BSA) have long called for an extension to the current cash Isa allowance of £3,600 per year.
The BSA also encourages the removal of tax on savings interest for basic rate taxpayers and is calling on the government to keep so-called “silver saver” accounts, which are aimed at pensioners and risk being out- lawed as part of the Equalities Bill.
Interactive Investor, a fund supermarket, believes getting rid of income tax on all savings could reduce the appeal of cash Isas, but may encourage more people to use Isas for equity investment.
However, reducing the tax burden would only help savers who are obtaining some return on their cash funds. Also, higher rate taxpayers would see no benefit as their savings income would still be taxed at 40 per cent.
The average rate on easy access savings accounts has dropped to around 1.5 per cent, according to Moneyfacts.co.uk and could go lower following this week’s rate reduction. So saving basic rate tax on interest, even on a balance of £50,000, would equate to just £150 per year on the average account.
Many accounts are already paying much less. HSBC is paying just 0.1 per cent on its online saving account – or 0.08 per cent after basic rate tax is deducted, for example.
Should rates drop to zero, there could be greater implications for savers, according to PwC.
“If interest rates fall to zero, taxpayers may end up paying their bank or building society to look after their money,” said Kerswill. This is because a number of saving accounts pay a margin below base rate.
Kerswill said HMRC may be able to help taxpayers who are adversely affected by low interest rates.
It could, for example, allow taxpayers to offset the loss of interest against tax on income earned elsewhere.
“Under current rules, individuals affected will not get a tax deduction for negative interest,” she said. “There’s an element of tails you lose and heads you lose too.”
