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New personal savings allowance comes into force

Published 04/04/2016

New savings schemes come into force this week
New savings schemes come into force this week

Many savers will no longer have to pay tax on the interest they earn when a shake-up comes into force this week.

From April 6, the new personal savings allowance will be introduced, meaning that b anks and building societies will stop deducting tax from account interest.

Basic rate taxpayers will be able to earn up to £1,000 in savings interest tax-free, while higher rate taxpayers will be able to earn up to £500.

Savings income includes account interest from bank and building society accounts, as well as accounts with some other providers, such as credit unions and Treasury-backed National Savings and Investments (NS&I).

It also includes some other types of income, such as that from government or company bonds.

Money held in tax-free Isas will not count towards the allowance as this cash is already ring-fenced from the taxman.

The move should bring some welcome relief to savers, who have suffered the effects of more than seven years of the Bank of England base rate being held at its record low of 0.5%.

According to financial website Moneyfacts.co.uk, savers are currently facing the worst Isa season on record.

Moneyfacts said the average Isa now pays just 1.29% in interest, a fall from 1.45% a year ago and 2.39% five years ago.

Many current accounts pay attractive rates by comparison, with deals offering interest of 3%, 4% and 5% as well as potential perks such as cashback and cash to join up.

One in 14 (7%) people plan to move money out of their Isa and into another savings account, according to research from AA Financial Services among more than 2,000 people.

But Michael Johnson, director of AA Financial Services, warned savers to carefully consider how the new allowance will affect them.

He said: "The decision on what to do with your money isn't as simple as comparing rates between saving accounts and Isas."

Mr Johnson said savers should consider how any future increase in interest rates will affect them.

For example, basic rate taxpayer with £50,000 in a savings account earning 2% will generate £1,000 interest - meaning all interest is protected by their personal savings allowance. But if their rate increased to 3% they would generate £1,500 - meaning £500-worth of interest will become liable to tax.

Any future pay rises could also affect how much of a saver's interest is tax-free. A pay rise taking a saver from a basic rate tax bracket to a higher rate tax bracket would halve their allowance from £1,000 to £500.

An advantage of Isas is that once the cash is put into one, it remains ring-fenced from the taxman until the saver decides to withdraw it. And the annual Isa allowance will increase from its current level of £15,240 to £20,000 from April 2017.

People saving into an Isa have an increasing array of options, on top of the traditional choice between a cash Isa and a stocks and shares Isa.

The Government recently launched Help to Buy Isas, which give savers trying to get onto the property ladder a cash bonus of up to £3,000. To receive that, someone will need to have saved £12,000.

Tom Riley, head of savings at Nationwide Building Society, said it would be "perhaps short-sighted" for people to think Isas are no longer relevant.

He said: "It's not just the here and now where I think Isas are an option because spouses can inherit their partner's Isa allowance upon death, whereas the new personal savings allowance can't be inherited.

"Also, f rom April 6, the Government is allowing providers to offer flexibility on Isas.

"So, with some providers, you'll be able to replace money withdrawn from some Isa products during the same tax year, without impacting your annual Isa allowance.

"Any withdrawals need to be replaced before the end of the tax year though and you can't carry forward any unused Isa allowance from previous years - so it's a case of use it or lose it."

April's savings shake-up also sees the launch of new Innovative Finance Isas, which will allow savers to potentially boost their returns further. I nnovative Finance Isas will be able to hold peer-to-peer loans, which often pay significantly higher returns than cash accounts.

Peer-to-peer lenders act as middlemen, matching people who have some cash to invest with those who want to borrow money.

However, money held with peer-to-peer lenders does not fall under the Financial Services Compensation Scheme (FSCS), which protects savers if their bank or building society goes bust, so investors need to bear in mind the risks.

In the recent Budget, the Government also unveiled plans for new Lifetime Isa accounts, set to be available by April 2017. These accounts can be opened by people aged between 18 and 40, and any savings they put in before their 50th birthday will receive an added 25% Government bonus.

The new Lifetime Isa accounts are intended as a way for younger people to save for their first home, and their retirement, in the same pot.

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