Martin Lewis has explained a little-known tax allowance (Image: ITV)
Martin Lewis has pointed pensioners to a tax-free allowance they may not realise applies to them. You may know about one tax-free amount you can earn each year but there is another “special allowance” that some people are entitled to.
The savings expert spoke on his BBC podcast about the under appreciated starting rate for savings, which can provide a big boost to your tax-free entitlements. Mr Lewis told listeners: “There is the personal savings allowance, which I suspect many listeners will know about, which says a basic rate taxpayer can earn £1,000 of interest a year on any form of savings without being taxed.”
‘Special allowance’
But the tax-free perks don’t stop there. Mr Lewis said: “There is another allowance that people don’t know about. It is called the starting savings allowance.
“What happens with the starting rate of savings is if you have high savings interest and low earnings, then it is a special allowance that means up to the first £5,000 of your savings interest can be tax free, plus you get the personal savings allowance on top.”
Mr Lewis said pensioners in particular may well benefit from this rule, as they may get a relatively low income from their pension savings, while they have a large pot of savings that they have built up over the years, earning a chunk of interest each year.
How does the starting rate for savings work?
The way the starting rate works is once you have used up the personal allowance, which allows you to earn up to £12,570 a year without paying income tax, you can earn another £5,000 of savings interest on top of this with no tax to pay on these interest earnings.
This allowance is reduced by £1 for each £1 you earn over the personal allowance through another taxable sources of income, such as from employment or your pensions. So once your income from other sources reaches a total of £17,570, you get no starter rate for savings.
This is separate from the personal savings allowance, which varies depending on which tax band you are in. For basic rate taxpayers, you can earn up to £1,000 of interest tax-free, while higher rate taxpayers get a £500 allowance.
People on the additional rate get zero allowance and have to pay tax on all their interest earnings outside of ISAs. Mr Lewis gave the example of a person with an income of £12,500 a year from a pension while earning £4,400 of interest from savings outside of an ISA wrapper, giving them a total taxable income of £16,900.
If they just had the £1,000 personal savings allowance on top of the personal allowance, they would pay 20 per cent on £3,330 of their income, with a £666 bill to HMRC. But thanks to the full £5,000 allowance from the starting rate being added to their personal allowance, none of their £4,400 interest payments would attract a tax bill.
£6,000 in tax-free allowances
In fact, they would get a total savings tax-free allowance of £6,000, so they could earn another £1,600 of interest earnings tax-free. Mr Lewis crunched the numbers: “Someone who earnt £12,570 from earnt income and had £6,000 of interest from savings outside of ISAs could have all £18,570 tax-free.
“Obviously, you’ll need to do some thinking about how this applies to you. Effectively it was set up for people who have a low earnt income and high savings interest.
“Primarily it’s pensioners who tend to be in that situation, who have got savings built up over the years but are no longer working and are just living off pensions that are at a relatively low level, and it works there.”