In the Budget of March 2015 Chancellor George Osborne announced that from 6 April 2016 individuals who receive savings income, such as interest on bank or building society accounts would receive an annual tax-free Personal Savings Allowance (PSA). At the same time he announced that banks, building societies and other institutions that deduct tax on the interest they pay to savers would cease doing so.
The PSA means that basic rate taxpayers will be able to receive up to £1000 of savings income, and higher rate taxpayers can receive up to £500 of savings income, without any tax being due. The PSA will not be available to any saver with additional rate income (over £150,000).
It's not just interest from bank and building society accounts that qualify but also from credit union accounts, corporate bonds, government bonds and gilts. Interest earned on other currencies held in UK-based savings accounts is also included as is interest received under the increasingly popular peer-to-peer lending arrangements. However dividend income from shares or investment funds is not included.
If you already save into a tax-free account such as an Individual Savings Account (ISA), interest from these will still be paid tax-free and won't count toward your PSA limit.
For people whose income from other sources, like salary is close to the threshold for higher rate tax you will need to look closely at which allowance you will be eligible for.
Here's an example:
2016/17 Tax Year - Tom has earnings from his employment in the year of £42,999 and £1000 in savings interest from bank and building society accounts.
The Personal Tax Allowance for the year is £11,000 and the higher rate tax (40%) threshold is £32,000.
As Tom's total income including interest is above the higher rate tax threshold he will only get the £500 personal savings allowance. So £500 of the interest he receives will be tax free whilst the remainder will be taxed at the higher rate.
The tax due on the interest will be payable by Tom through the self-assessment system on 31 January 2018, or if he is not in that system, through changes to his Tax Code. He will get a restriction in his Personal Allowance which will recover the tax due on the savings interest through his salary.
If Tom was married and the interest received from savings was all from joint accounts with his wife he would be assumed to have received just half of the interest (£500) whilst his wife received the other £500. Tom would therefore have no higher rate tax to pay.