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Individuals with savings could be in for an unpleasant revelation regarding savings tax. HM Revenue & Customs (HMRC) is responsible for collecting the due tax on savings interest earned by savers.
However, recently disclosed documents accompanying the Chancellor’s Spring Statement indicate that HMRC has not been effectively collecting this revenue. Savers have inadvertently underpaid tax on interest by hundreds of millions of pounds annually. As HMRC rectifies its processes and addresses this backlog, individuals may encounter significant and unexpected tax demands.
Here’s an explanation of the situation and advice on how to safeguard your finances.
Savings Tax Oversight: What’s Happening?
An increasing proportion of savers are now subject to tax on savings interest income. Fortunately, in the majority of instances, taxpayers do not need to take direct action to remit this tax, as the payment is typically automated.
Banks and building societies furnish HMRC with details of the interest earned by their savings customers. Subsequently, HMRC calculates whether any tax liability is due.
Where tax is owed, HMRC recovers the due amount directly from employed individuals through adjustments to their pay packet. For savers who are part of the Pay As You Earn (PAYE) system or receive pension income, their tax code is revised downwards, resulting in slightly reduced monthly take-home pay until the outstanding tax is settled.
Self-employed individuals are required to declare any savings interest earned on their self-assessment tax returns. For those who are neither employed nor pension recipients and do not complete tax returns, HMRC should make direct contact to inform them of any tax obligations and provide payment instructions. This is the intended procedure.
A consultation document from HMRC reveals systemic issues in accurately matching data from banks and building societies with their internal records. The scale of this problem is such that data reconciliation fails for approximately one in five bank accounts.
HMRC is currently consulting on proposed measures aimed at improving the alignment of their records with financial institutions. Upon implementation, savers who have accrued interest that previously went unnoticed may be presented with tax bills for previously untaxed savings income.
Potential Financial Impact for Savers
Mark Levitt, partner at Blick Rothenberg, an accountancy firm, cautions that where savers have not been correctly taxed, HMRC possesses the authority to retrospectively investigate up to four years to ascertain the precise amount of interest owed.
Individuals may also be required to review their financial records. HMRC retains the power to reclaim unpaid tax, even if the underpayment was not the taxpayer’s fault. ‘If the funds have already been spent, it might be possible to negotiate a payment plan,’ Mr. Levitt suggests. ‘Otherwise, HMRC is likely to adjust your tax code downwards, leading to a decrease in your take-home salary.’
Factors Contributing to the Issue
For many years, prevailing low interest rates meant that only the wealthiest savers exceeded their personal savings allowance, the threshold for tax-free interest earnings.
However, with the rise in interest rates, even individuals with modest savings balances could now surpass this allowance. Older savers, particularly those who depend on savings to supplement their income, are especially vulnerable to incurring tax liabilities.
Approximately 6.1 million savings accounts are currently liable for tax, a significant increase from 1.5 million in 2022 and a mere 147,000 in 2021.
The personal savings allowance permits basic rate taxpayers to earn up to £1,000 in interest without paying tax, while higher rate taxpayers have a £500 allowance. Additional rate taxpayers do not receive an allowance. Once these thresholds are exceeded, tax becomes payable on interest at the individual’s income tax rate. Basic rate taxpayers are taxed at 20 percent, higher rate taxpayers at 40 percent, and additional rate taxpayers at 45 percent.
With current top savings rates exceeding 5 percent, a basic rate taxpayer could face a tax bill with savings as low as £20,000. For a higher rate taxpayer, a tax liability could arise with just £10,000 in savings.
Recommended Actions for Savers
If your interest income remains within your personal savings allowance, no tax will be due. If you anticipate exceeding your allowance, consider utilizing Individual Savings Accounts (Isas) instead of standard savings accounts, as interest earned within an ISA is automatically exempt from tax.
Furthermore, if you have already maximized your £20,000 ISA allowance and are approaching or have exceeded your personal savings allowance, either currently or in previous tax years, it is advisable to verify that you have paid the correct amount of tax to avoid unexpected future tax demands. Your savings providers should furnish you with annual statements detailing your interest earnings for each tax year.
For individuals with multiple savings accounts, aggregating the interest earned across all accounts will help determine if you have breached your allowance. You can also access your personal tax account online to cross-reference your records with the figures held by HMRC.
If a discrepancy exists for the current tax year, it is possible that the matter will be automatically resolved in due course. HMRC projects anticipated interest earnings based on the previous year’s figures and makes adjustments once accurate data becomes available.
‘It is prudent to proactively review your savings accounts to ascertain your earned interest before HMRC fully addresses this issue,’ Mr. Levitt advises.
Potential Exemptions for Low-Income Savers
Individuals on lower incomes may be eligible to earn up to £5,000 in savings interest without incurring any tax.
This is known as the starting rate for savings. For every £1 of income earned from sources other than savings interest that surpasses the personal allowance (currently £12,570), the starting rate for savings is reduced by £1. If your other income exceeds £17,570, the starting rate for savings will not apply.