How To Pay Zero Taxes On £100k Savings

"Ninety-five per cent of savers will be taken out of income tax altogether." That was the promise made by George Osborne, the then chancellor, when he announced a new savings tax regime in the 2015 Budget.

But actually managing to avoid paying any tax on your savings can be easier said than done.

To achieve that zero tax bill, or even the lowest possible tax charge, savers have to navigate a complicated series of reliefs, whose usefulness depends on other circumstances such as their exact earnings from other sources.

To illustrate the problem and help readers get the most from the various tax breaks on offer, we look at three imaginary savers, each with £100,000 to deploy: one has a total income of about £10,000, another earns £25,000 and the third makes £50,000.

Earnings of £50,000 a year

The main tax breaks for savers come from cash Isas, the personal savings allowance and the little-known "starting rate for savings".

The last of these is available only to those on low incomes, such as our £10,000 saver below, so the choices available if you earn £50,000 are the Isa and the personal savings allowance.

SavingsChampion, the savings rate analyst, said a typical saver with £100,000 could expect to earn £2,132 a year in interest before tax if they chose a range of best-buy accounts (which would allow them to hedge their bets in terms of benefiting from any future interest rate rises while obtaining the highest rates possible on some of their money).

If the saver puts the maximum amount allowed into an Isa, which is £15,240 this tax year (rising to £20,000 from April 6, 2017), the £183 interest paid will automatically be tax free.

The saver can also benefit from the personal savings allowance, although as a higher-rate taxpayer only £500 can be earned tax free.

This leaves £1,449 on which 40pc income tax, or £580, is payable. This cuts the interest received to £869 and the saver ends up with £1,552 total interest after tax.

Another £20,000 can be put in a cash Isa when the new tax year begins on April 6. This would mean a tax bill of £378 and ultimate interest received of £1,600.

Earnings of £25,000 a year

This saver can also use cash Isas and the personal saving allowance (although not the "starting rate").

Additionally, as a basic-rate taxpayer, he or she is entitled to the full personal saving allowance of £1,000 a year. The total annual interest earned is again £2,132.

Again, £183 tax-free interest can be earned from the Isa, and the £1,000 personal saving allowance means that £949 is subject to tax.

This time the rate payable is 20pc, making £190 due in tax and the net interest received £759. When added to the interest from the Isa and the £1,000 under the personal saving allowance, the total interest after tax is £1,942.

If next year's Isa allowance is also used in April, the tax bill will fall to £89 but the after-tax income will be lower at £1,889.

This is because the absence of tax to pay on the Isas is outweighed by the fact that the interest rates available on Isas are currently lower than on ordinary accounts.

Earnings of £10,000 a year

On this occasion the usually forgotten "starting rate" of tax for savings comes into play.

This rate is actually zero, although it was previously 10pc.

The perk applies to up to £5,000 in savings interest, but only if your total income from other sources is £16,000 or less - and every £1 of non-savings income above your personal allowance (currently £11,000) cuts the amount eligible for the starting rate by £1.

This saver does not even need to use Isas to avoid paying any income tax: in fact, just the starting rate on its own is enough, although the personal savings allowance is also available.

With no non-savings earnings above the £11,000 limit, the saver qualifies for the full £5,000 exemption under the starting rate.

Because some ordinary taxable savings accounts pay better rates than Isas, this saver actually earns more in interest, £2,270, and is entitled to keep it all of it, with no tax to pay.

The lessons

These examples show us that, while the various savings tax breaks are all useful, the actual benefit from each varies according to your circumstances.

The saver who earns £10,000 a year, for example, would end up with less interest, before or after tax, if he or she used the most popular tax shelter, the Isa.

The other savers would also earn more by avoiding use of Isas - but only if current differentials in interest rates are maintained.

It is impossible to say that this will happen indefinitely into the future, so experts advise savers to make full use of Isas every year to ensure that their money is permanently protected from tax.

Tax breaks on pensions and dividends have been cut recently and it's not impossible that the personal savings allowance could follow suit, whereas considerable uproar could be expected if Isas were attacked.

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