“I’m sorry to hear that mortgage rates have gone up. It can definitely be frustrating to see your expenses increase. Additionally, it’s important to keep an eye on changes to tax laws that could affect your savings. Have you considered speaking with a financial advisor to see if there are any strategies you can implement to minimize the impact on your finances?”
Especially in 2023, purchasing a home is unquestionably one of the most difficult and costly things you can do.
The housing market is highly unstable since mortgage rates are growing alarmingly and home values are beginning to decline.
However, many people still wish to purchase their own home. Homebuyers have been saving every cent for the past few years to buy their dream homes.
They should be commended for accumulating this large sum in a savings account!
But there’s a catch, and it’s a huge one.
Since they also increase returns on your investments, rising interest rates impact more than just mortgages. However, if your funds are held in the incorrect type of account, you can soon have to pay tax on them.
How savings are taxed
Thanks to a combination of low interest rates and something called the Personal Savings Allowance (PSA), we haven’t had to worry about this for a very long time.
According to the PSA, basic-rate taxpayers are exempt from paying taxes on their first £1,000 of interest. Alternatively, this limit is significantly lower at £500 if you are a higher-rate taxpayer.
For those with incomes under £12,570, there is also the starting savings rate, which entitles them to a £5,000 starting savings limit and a PSA of £1,000 tax-free. However, that is a different situation.
How taxes affect your savings rates
Your savings rates might be significantly impacted by taxes. The taxes you pay on your income and investments can directly affect how much money you have left to save. For example, if you are in a higher tax bracket, you may have less disposable income to save after taxes. Additionally, invest in assets that generate taxable income, such as bonds or rental properties. In that case, you may need to pay taxes on that income, which can further reduce your savings rate. Therefore, it’s important to consider the tax implications of your investments and income when determining your savings rate. You can uncover strategies to maximize your savings and reduce your tax liability by consulting a financial counselor or using internet resources.
The savings accounts that are never taxed
Any contributions made in a lifetime ISA or a Help to Buy ISA are tax-exempt, which is wonderful news.
However, you may transfer up to £20,000 a year into your old buddy, the cash ISA, if you have money elsewhere and don’t want to pay taxes.
We’ve had a rocky relationship with ISAs over the years since its key selling point of tax-free savings appeared useless with interest rates this low.
So far, at least.
If you are currently saving to purchase a property, an ISA could be the best option for your funds. This is because if you use your limit of up to £20,000 annually, you won’t be taxed on your savings.
A 1-year fixed-rate ISA’s interest rate reached 5.5%, which is fantastic news because ISA interest rates have also been climbing. So, are we better off if we take our £20,000 back again?
You might make £1,100 in interest with no deductions in a cash ISA with a 5.5% interest rate. However, unless you are a higher-rate taxpayer, you would earn £1,176 with the above fixed-rate bond.
A fixed-rate bond is still the best choice in this situation, but things would be different if you had more cash. Saving more money would result in higher interest rates, resulting in a significant loss of tax revenue.
So, let’s assume you and your partner have saved £40,000 and you want to transfer it to a one-year fixed-rate bond since you won’t be moving until 2024. You and your partner are both basic tax payers. After a year, you will have earned £2,440 at a rate of 6.1%, but £288 will have been taken out, leaving you with a total interest pot of £2,152.
Instead, if you and your spouse invested £20,000 in a cash ISA paying 5.5%, you would earn £2,200 total—£48 more than the fixed-rate bond—without paying any tax on it.
Therefore, if you have a lump sum of money saved, it’s crucial to examine various savings accounts and take tax into consideration when determining how much interest you may earn.
How much money does a higher-rate taxpayer need to have in savings to be taxed?
Higher-rate taxpayers in the UK are taxed on savings income over £500, while additional-rate taxpayers are taxed on savings income over £1,000. It’s important to note that these thresholds may change depending on individual circumstances, so it’s always a good idea to consult with a financial advisor or HM Revenue and Customs for specific information.
