The 10 per cent starting rate for savings

Monday 14 April 2008

Much has been made in the press recently about the abolition of the 10 per cent starting rate for income tax and the effect this will have on lower paid workers. However a 10 per cent starting rate for savings income still applies. So who qualifies for this "new" starting rate and how will it apply?

What are the changes?

The old 10 per cent starting rate for income tax was abolished with effect from 6 April 2008. For the 2008/09 tax year, and subsequent years, a new 10 per cent band applies for savings income only. However, whether or not the new 10 per cent savings rate applies will depend on the amount and types of income the individual receives.

How will income be taxed going forward?

Income sources are taxed in the following order: first non-savings (eg earnings, pension income, rental income), secondly savings (eg bank interest) and lastly dividends.

What this means is that certain individuals whose income is less than the combined amount of the personal allowance and the 10 per cent starting rate will be taxed at only 10 per cent on any savings income above the personal allowance up to the starting rate limit for savings of £2,320 (for 2008/09). Should any taxable non-savings income exceed the starting rate limit for savings, the 10 per cent savings rate is not available and savings will be taxed at 20 per cent up to the basic rate limit of £36,000.

This is probably best demonstrated with some examples.

Example 1

Barbara is 67 and receives a state pension of £4,800 and a pension from her former employer of £5,000. She receives interest on her savings of £400 after a deduction of tax of £100 (£500 gross).

Barbara's personal allowance of £9,030 (age related allowance for those aged 65- 74) is offset against her non-savings income (ie her pensions). This leaves £770 of her pension income taxable at 20%. Her taxable savings income is £500. As the total of her taxable savings income and non-savings income (£770 plus £500) is less than the savings income threshold of £2,320, her savings income is only taxable at 10%. Therefore, Barbara may need to claim a refund for overpaid tax as the tax deducted at source on her savings was at a rate of 20%.

Example 2

Tom is 68 and receives a state pension of £5,000 and income from a retirement annuity of £6,000. He receives interest on his savings of £800 after deduction of tax of £200 (£1,000 gross).

Tom's personal allowance of £9,030 is offset against  his non-savings income (ie his pensions). This leaves £1,970 of his pension income taxable at 20%. His taxable savings income is £1,000. As the total of his taxable savings income and non-savings income (£1,970 plus £1,000) is more than the savings income threshold of £2,320, only £350 (£2,320 minus £1,970) of his savings income is taxable at 10% with the remaining £650 taxable at 20%.

However, Tom may still be entitled to claim a refund as part of his savings income should have been taxed at 10%, rather than 20%

Example 3

Eric is 50 and receives a salary of £25,000 and savings income of £200 after deduction of tax of £50 (£250 gross).

As Eric's salary exceeds his personal allowance and savings income limit (£5,435 plus £2,320), all of his taxable savings income of £250 will be taxable at 20%.

Mike Warburton, Senior Tax Partner at Grant Thornton says: "As with most changes to the tax law, there will be some winners and some losers from the new income tax rules. However, the interaction between the rules for the new savings rate and the order in which income is taxed means it will be difficult for the average man or woman on the street to calculate their position and work out whether or not they may be due a refund."

"In particular this could be problem for pensioners who may not realise that they are entitled to make a reclaim and miss out."

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