CashQuestions - Low rates can mean tax-free interest

Low rates can mean tax-free interest

02 February 2010

There is some compensation for the rock-bottom rates currently being paid on savings: some elderly people who rely on the interest to top up their meagre pensions could find that their total income has now fallen below the annual tax-free threshold, and that could entitle them to receive their interest income without tax deducted.

Falling interest rates on savings over the past 18 months have been bad news for people on modest fixed incomes. These record low rates made ISA benefits barely worthwhile, and made it almost impossible to find a savings account that keeps pace with inflation.

Because the rate cuts have been so drastic, it could mean that the total annual income for some consumers has now fallen below the tax free threshold.

Andrew Hagger of Moneynet.co.uk has come up with the following example:

Single pensioner aged over 75 has an annual tax free allowance of £9640

Income	Annual income
In receipt of state pension £95.25 per week	£4953
Occupational pension £85 per month	£1020
£60,000 savings at 7% interest(note ISA savings do not have to be counted as they are tax free)	£4200
Total annual income	£10173
Annual income exceeds the tax free threshold, therefore £4200 interest income is taxable – at 20% that amounts to £840, so net interest income from savings is reduced to £3360

However i f you look at the same scenario with a much lower savings interest rate of 3.5%

Income	Annual income
In receipt of state pension £95.25 per week	£4953
Occupational pension £85 per month	£1020
£60,000 savings at 3.5% interest	£2100
Total annual income	£8073
Total annual income = £8073 therefore below the tax free threshold which means savings interest £2100 qualifies to be paid gross (saves £420 which would be taken in tax if R85 not completed)

Mr Hagger points out that this situation will not apply to everybody, but for those who are not sure if they are affected there is an HMRC help sheet, accessible by clicking on
http://www.hmrc.gov.uk/helpsheets/r85-helpsheet.pdf and a telephone helpline is available on 0845 980 0645.

Anyone who establishes that they qualify for interest without deduction of tax will need to complete form R85 and hand it in to the savings provider.

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