The new calendar year may be truly underway now, but the new tax year is still approaching. As always, this is going to bring some changes and the biggest change for many people will be the introduction of the new personal allowance for savings interest.
From 6th April onwards, there will be a tax-free personal allowance on all income generated by savings, similar to – but separate from – the personal allowance for employment income. For basic rate taxpayers, the first £1,000 of interest on savings will be exempt from tax, regardless of whether those savings are stashed in a tax-free ISA or a different kind of savings account. For higher rate taxpayers, the allowance on savings income will be £500. The only ones who do not benefit at all from this change will be those who pay the 45% additional rate of tax. Those who fall within this top tax band will not receive an allowance on savings.
The changes are undoubtedly good news for the great majority of savers, but they also have the potential to create confusion. Suddenly, a lot of the things that are currently common knowledge about financial planning and where best to put savings have been shaken up, and some people find they are not sure what best to do with their money when the changes have taken effect.
For example, it has long been the case that putting as much money as you can into an ISA each year is a no-brainer. However, the reason for this was the fact that no tax would therefore be payable on interest. Now that the first £500-£1,000 of interest is going to be tax-free for the vast majority of savers anyway, the place and purpose of ISAs is looking less clear.
ISAs will continue to exist, but unless your savings are likely to generate interest in excess of your personal allowance they will not be the essential savings wrapper they once were. Assuming the interest you earn is going to fall within your personal allowance, instead of just looking at ISAs you should look for the best interest rate you can get regardless of whether it is a dedicated tax-free account or a regular savings account.
This is particularly pertinent at the moment, as the changeover approaches. In theory there is no reason not to keep your money in an ISA unless you can earn more elsewhere, but there is a good chance that you will earn more in a different account. Many non-ISA savings accounts have long offered better rates, but the tax-free advantage of ISAs has meant they have still been the more profitable option on the whole. Now the playing field has been levelled for many savers, it may be time to switch away from an ISA and into a higher-paying savings account. Whether there will be any shake-up of rates after the changes take effect that may change this remains to be seen, but any rate you switch to now should be guaranteed for some period.
If your savings are substantial enough to earn interest in excess of your allowance, then the best bet is probably a mixed approach. Put enough of your savings to use up your allowance in the highest-paying accounts you can find, and then as much of the remainder as possible into ISAs to maximise tax-efficiency.