The personal savings allowance (PSA) and dividend allowance are often misunderstood because any income covered by the two allowances still counts towards a taxpayer’s adjusted net income figure. A small amount of dividend or savings income can therefore have a significant impact on your tax position.

Unlike the £1,000 trading and property allowances, which actually exempt that amount of income, the savings and dividend allowances are nil rate bands of tax. Higher rates of interest have simply exacerbated the problem in regard to the PSA.

Income levels

The key income levels are:

• Net income of £50,270: Go just a pound or two over this threshold and the PSA is reduced from £1,000 (for a basic rate taxpayer) to £500 (higher rate taxpayer). Also, the transferable marriage allowance will no longer be available.
• Net income of £60,000: At this level of income, a taxpayer may start to incur the high income child benefit charge. Although only a small additional amount of tax is going to be due if the threshold is exceeded by just a few pounds, it might mean having to file a self-assessment tax return for those otherwise paying tax through PAYE.
• Net income of £100,000: The personal allowance is tapered away once income exceeds £100,000, resulting in a high marginal income tax rate of 60%.
• Net income of £125,140: Entitlement to the PSA ceases altogether once income exceeds this amount.

 Implications

It is important that savings and dividend income is accurately reported to HMRC even if it is covered by the PSA or dividend allowance because there could be tax implications you have not considered. Reporting an estimated figure on the assumption it will make no difference to your tax position could lead to a subsequent unexpected tax bill if HMRC picks up on the correct figure. Given that banks and building societies submit details of untaxed interest to HMRC after the tax year has ended, this is quite likely.

If a self-assessment tax return is not required, taxpayers can report details of their savings and dividend income to HMRC using their personal tax account.

Mitigation

There are two straightforward ways to mitigate the impact of having too much savings and/or dividend income:

• Move savings and investments across to individual savings accounts where income will be exempt.
• Make pension contributions. The gross amount of contributions will increase your adjusted net income figure, so that the impact of having too much savings and/or dividend income will be cancelled out. However, careful planning is required here because contributions must be paid before the end of the relevant tax year.

Even if the key income levels are not in play, you need to be aware that the amount of PSA has not changed since its introduction in 2016. Apart from the impact of fiscal drag eroding the value of this allowance, high interest rates now mean many are receiving much higher amounts of interest.

Interest rates shift

When interest rates were around 0.5%, the PSA of £1,000 would cover the income received on savings of up to £200,000. With interest rates of around 5%, that figure has come down to £20,000. The dividend situation has changed even more dramatically, with the dividend allowance having been cut from its original £5,000 down to just £500.

Scottish tax rates and thresholds differ.