How the personal savings allowance can make you more money
One evident theme since the EU referendum last year is the currency of GBP being more volatile than Charlie Sheen’s sex life. The long-term trend of a weaker sterling has and will have many consequences. Arguably, it has been one of many key forces driving inflation higher over recent months. Yep you guessed it, this impacts the money saving and investing millennial directly.
With inflation expected to continue jumping higher and savings rates not looking to rise anytime soon, the spending power of our savings is being questioned. If inflation is higher than your savings interest, you are effectively losing money. Meaning; your savings now buy you a lower quantity of goods.
So, when people ask, ‘Where should I invest the spare cash I have sitting in my savings account?’ I think, slow down tiger, the first port of call is not to begin investing aimlessly, but to widen your understanding of what’s out there. I am here to give you the tools to make better money decisions, whilst act as a foundation for further research!
This week, I am going to look at the not so new concept of the Personal Savings Allowance aka the PSA. When I last mentioned the concept of a PSA, it was unfortunately confused for a protein shake brand. So, let’s give our knowledge base a quick pump!
THINGS TO NOTE:
The PSA came into full effect on the 6th April 2016
It allows you to earn up to £1,000 in interest each year without paying any tax on it
This includes account interest on things such as a savings account, high interest current accounts, income from government bonds and much more.
Notably, interest that is already insulated from tax is not included in your limit - Take your ISA interest for example, it will still be paid tax-free and it won’t count towards your PSA limit.
WHAT’S THE CATCH THEN?
The catch is, the amount of tax-free cash you can earn depends on which tax bracket you fall under.
Basic rate tax payers (20%) get the full allowance of £1,000 each year
Higher rate payers (40%) can earn up to £500 tax-free a year
You city folk who sit nicely in the 45% tax bracket don’t get the allowance - Don’t you tut at me, you can’t have it all!
WHAT DOES THIS ACTUALLY MEAN?
Well, most people will no longer pay tax on savings interest, whilst those fat cat bankers have stopped deducting tax from your interest earned since the launch date last year.
Let's walk through a few examples:
Scenario 1: Let’s say you earn £20,000 a year and earn £250 a year in account interest. Happy days as you won’t be paying any tax on that interest because it’s less than your £1,000 PSA.
Scenario 2: You earn £20,000 a year and earn £1,500 in account interest. You won’t pay tax on the £1,000, but you will pay the basic tax rate of 20% on the £500 (the amount above the threshold).
Scenario 3: This one is for those millennial heavy hitters. Say you take away £60,000 a year and get £1,100 in what they call account interest. You would pay NO tax on your limit of £500, however, you then pay 40% on the £600 above your PSA.
£1,000 IS NOTHING THOUGH!? WHAT A LOW LIMIT!?
You may think £1,000 is nothing, however, you would be mistaken. If I was having this conversation with you on the 5th July 2007 when the Bank of England raised interest rates to 5.5%, we would be having a very different discussion. However, the glory days have gone, so you would actually need a very healthy pool of savings before you hit the relevant thresholds.
Food for thought: According to the BBC in 2016, around 16 million people in the UK have less than £100 in savings!
EXCITED…BUT WHAT DO I NEED TO DO?
Millennials might be scratching their heads as to what they should be doing to get bang on it. The answer is nada - Everything is done for you in the background to make it as easy as possible for you.
The HMRC will normally collect the tax by automatically changing your tax code. Your bank have been giving the HMRC the information they need to do this since last year. For those millennials who operate in the so called ‘gig economy’, you will still be completing your self-assessment tax return as per normal.
You may wonder why I am banging on about something that was released last year - Well before we move forwards we have to take a little trip down memory lane
IN A NUTSHELL…
It really isn’t ground-breaking stuff, however, it just gives you a great way to earn tax-free interest across a range of so many different products. We all hate lifting a finger, so the nice thing here is that it has been going on in the background since last year without many of us knowing it!
Why should I bother with an ISA then? The world of UK money has been going back and forth on this exact debate over the past year. As a fellow millennial my view is that if you exceed your PSA limit or are a top-rate tax payer, the next stop is to put any additional savings into an ISA. Many will beg to differ, however, it should always remain a part of everybody’s financial planning. The ISA family offers great long-term benefits and your suitability for each product is key. Next stop….what on earth is an ISA?
Updated as of 30th Jan