Simple switch that could boost your savings by an extra £5,000 – anyone can do it and it takes minutes
SAVERS can boost their nest eggs by making a very simple switch, and it takes just minutes to set up.
Historically, only higher earners have been hit with tax bills for saving their cash.
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But in recent years, the personal savings allowance – the amount you can earn in savings interest before paying tax – has been frozen, and at the same time, interest rates on savings have been rising.
This means even some lower earners have been stung with tax bills for saving their pennies.
The two factors combined have seen lots more savers than usual being dragged above the personal savings allowance threshold, which is currently £1,000 for basic rate taxpayers.
Recent figures by broker AJ Bell revealed the Government netted over £6.6billion from 2.75million people who had to pay tax on their savings last year.
That equates to around one in 20 basic rate taxpayers, and one in six of those who earn enough to pay higher rate tax (currently £50,270 a year).
For comparison, just 972,000 taxpayers had to pay tax on their savings in 2021/2022.
But there is an easy move you can make to avoid paying tax on your savings interest, and that’s switching to a cash ISA.
ISAs are completely shielded from income tax, meaning you get to keep more of your savings over time compared to opening a traditional savings account.
Charlene Young, pensions and savings expert at AJ Bell, said cash ISAs are currently offering better rates than savings accounts at the minute, too, based on figures from data provider Moneyfacts, so you could earn more on your savings.
AJ Bell calculated that a typical earner saving roughly the average amount, based on ONS figures, could save over £5,000 long-term by switching from a savings account to a cash ISA.
It found a basic rate taxpayer starting with no savings at all and adding £200 a month would save £1,280 in tax over 15 years by saving into a cash ISA instead of a regular savings account.
And the savings are even bigger for higher earners or those starting with a bigger nest egg.
For example, a higher rate taxpayer starting with £2,500 in a cash ISA and adding £200 in each month would be £5,421 better off after 15 years, compared to putting the money into a traditional savings account paying 5% interest.
The average amount someone aged between 40 and 44 saves is around £189 a month, according to the ONS.
Based on AJ Bell’s figures, a basic rate taxpayer would have to start paying tax on their earnings after seven years of saving into a regular savings account.
And it would take a higher rate taxpayer just four years to start paying tax on their earnings.
What is an ISA?
Savers can put away £20,000 a year into Individual Savings Accounts, also known as ISAs, and any income or gains you make from them are shielded from tax.
This is different to regular savings accounts, where you are taxed on income earned from interest once you breach a certain limit – known as the Personal Savings Allowance (PSA).
Basic rate taxpayers have a PSA of £1,000 while higher rate taxpayers get £500.
Anyone who is an additional rate taxpayer (taxed at 45%) has to pay tax on any interest they earn and gets no allowance at all.
You can split your £20,000 ISA limit between multiple ISAs, whether that’s a cash or stocks and shares ISA (we explain the difference below).
You don’t have to save the full £20,000 a year either – the most recent figures from HMRC show over five million people paid in £2,500 or less – just over £200 a month.
What type of ISA should I choose?
There are five main types of ISAs you can take out and each has its own perks and setbacks.
Cash ISAs
Cash ISAs are accounts you can save your cash into, and the money will sit in the account and generate interest.
These ISAs come in different forms and each one may be useful to you depending on your circumstances.
Do I need to pay tax on my side hustle income?
MANY people feeling strapped for cash are boosting their bank balance with a side hustle.
The good news is, there are plenty of simple ways to earn some additional income – but you need to know the rules.
When you’re employed the company you work for takes the tax from your earnings and pays HMRC so you don’t have to.
But anyone earning extra cash, for example from selling things online or dog walking, may have to do it themselves.
Stephen Moor, head of employment at law firm Ashfords, said: “Caution should be taken if you’re earning an additional income, as this is likely to be taxable.
“The side hustle could be treated as taxable trading income, which can include providing services or selling products.”
You can make a gross income of up to £1,000 a year tax-free via the trading allowance, but over this and you’ll usually need to pay tax.
Stephen added: “You need to register for a self-assessment at HMRC to ensure you are paying the correct amount of tax.
“The applicable tax bands and the amount of tax you need to pay will depend on your income.”
If you fail to file a tax return you could end up with a surprise bill from HMRC later on asking you to pay the tax you owe – plus extra fees on top.
Easy-access cash ISAs let you put your cash in and withdraw it at any time without paying a penalty.
Fixed-rate cash ISAs tend to offer higher interest rates than easy-access ones, but you will have to pay a penalty to take out cash during the fixed term.
Notice cash ISAs let you withdraw your cash without paying a fee, but you have to give a certain number of days’ notice.
All cash ISAs worth up to £85,000 are protected by the Financial Services Compensation Scheme, if it is in a UK-regulated bank or building society account.
Under the scheme, you are compensated when a financial firm, such as a bank, fails.
Stocks and Shares ISAs
Stocks and hares ISAs allow you to invest the money you deposit into shares and bonds, among other investments.
There is more risk with a stocks and shares ISA as you could lose money if markets fall.
However, while the value of the cash can drop during times of market volatility, investments typically tend to perform better over time than holding money in cash.
It’s important to ensure you can afford short-term losses before deciding to invest your money.
Figures from analyst Moneyfacts show cash ISAs outperformed them last year, returning 3.73% interest compared to returns of 2.8% for stocks and shares ISAs.
However, research by AJ Bell fr Moneyweek last month found stocks and shares ISAs investing in global equities grew by 65.7% while cash ISAs returned 5.5% in total.
Usually, you have to pay some fees with a stock and shares ISA to cover the platform managing your investments.
For example, you may have to pay a “platform charge” which is either a flat fee or a percentage of the funds.
You may also have to pay an annual management charge which is paid to the fund manager.
The charge is a percentage of your total investments.
You may also have to pay a transfer out fee if you transfer your stocks and shares ISA from one platform to another.
Lifetime ISAs (LISAs)
Lifetime ISAs (LISAs) have replaced Help to Buy ISAs, which were created to help first-time buyers get on the property ladder.
Anyone between 18 and 39 can open a LISA and deposit a maximum of £4,000 per tax year into one.
These accounts offer a 25% government bonus on your balance, up to a maximum of £1,000.
You can keep adding money into one up until you are 50 and must make your first payment into one before the age of 40.
There are two different types of LISA – a cash LISA and a stocks and shares LISA.
A cash LISA can be worthwhile if you are saving for your first home and are planning to buy within a couple of years.
A stocks and shares LISA might be more worthwhile if you are saving for retirement, or have a longer time-frame over which you’re planning to save for a home.
With any LISA, you will have to pay a fee if you want to use the money for anything other than your first home or retirement.
As an example, if you had savings worth £800, you would earn a 25% bonus of £200 on top – bringing your total pot to £1,000.
If you wanted to withdraw the entire pot early, you would have to pay a 25% early exit fee on the full amount, which would be £250.
That means you would end up with £750, effectively losing £50 of your own money.
IFISAs
Anyone 18 or older can open an Innovative Finance ISA (IFISA) and deposit a maximum of £20,000 into one each tax year.
The company offering you one of these ISAs will use your money to lend to borrowers or businesses, and the idea is that you get interest back based on the interest rate charged on the borrower’s loan.
But you can lose money through an IFISA if the people you’ve lent to can’t afford to repay the loan.
Another disadvantage is that it can take a while to withdraw money from one.
Make sure you can afford any losses before opening an IFISAs.
Do you have a money problem that needs sorting? Get in touch by emailing [email protected].
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