New tax year sees major changes to the way interest and dividends are taxed

The new tax year saw major changes to the way interest and dividends are taxed. With the introduction of two new allowances, plus increases to existing allowances, the Treasury estimates that 95% of savers will no longer pay any tax on their savings.

WEALTH at work, a leading provider of financial education in the workplace, supported by guidance and advice looks at how employees can make the most of the savings options currently available to maximise income in retirement.

Previously, for every £100 of interest earned a basic rate taxpayer paid £20 in tax and a higher rate taxpayer £40. However, since 6 April 2016, basic and higher rate taxpayers are eligible to receive some savings income completely tax free through the introduction of a new Personal Savings Allowance (PSA).

The new PSA means basic rate taxpayers can earn up to £1,000 in savings income tax free, while higher rate taxpayers can earn up to £500. Savings income includes interest earned on bank and building society accounts, plus interest from other investments such as corporate bonds and gilts.

A basic rate tax payer would be able to save £100,000, earning 1% interest before having to pay any tax, and a higher rate tax payer can save £50,000 at 1% before paying any tax. There is no allowance for additional rate tax payers.

Jonathan Watts-Lay, director, WEALTH at work, said: “There hasn’t been much news on this but in this current low interest rate environment, this new allowance is potentially a big win for savers. But it’s worth noting that while £1,000 a year interest seems a lot, if interest rates rise in the future then employees could find themselves reaching the limit much sooner. For example, if interest rates reach 5%, a basic rate tax payer would only be able to save £20,000 before paying any tax, and a higher rate tax payer only £10,000. At this point, this is where other saving vehicles, such as ISAs, could prove useful.”

Changes were also made to the taxation of dividends. The 10% dividend tax credit has been replaced by a new tax free Dividend Allowance of £5,000. This means that share owners won’t have to pay tax on the first £5,000 of dividend income, no matter what other income they have.  However, dividends still count towards the basic and higher rate bands and so may affect the rate of tax paid on dividends received above the allowance.

Watts-Lay added: “Again, this is where ISAs are very useful, as dividends from shares held in ISAs remain tax free. ISAs play a big part in creating a tax-efficient investment strategy, especially as they not only shelter investment income from tax but also capital gains. Additionally, there is no need to keep records of ISA returns for the taxman as these investments don’t have to be declared on a self-assessment tax return.

Sign up to our newsletters

Receive news and guidance on a range of HR issues direct to your inbox

This field is for validation purposes and should be left unchanged.

“Employees should speak to their employers to find out if they offer Workplace ISAs. Not only are these an easy way to contribute to an ISA as it comes directly from the salary, there are also lots of perks and discounted fees including reduced or no initial charges, reduced management fees and reduced fund switching fees.

“These are just some of the savings vehicles employees could utilise while saving for retirement. The pension changes brought freedom and choice for pension savers, meaning all savings must now be considered. This includes pensions, ISAs, shares and any cash savings, plus that of their partners. Also things like an individual’s tax status, health, longevity, property and any possible inheritance or additional assets, all need to be taken into account. Well-thought-out planning can help savers to pay the least amount of possible tax and maximise income in retirement.”