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Paul Lewis is a multi award-winning financial journalist with more than 35 years’ experience, and is a regular presenter of BBC Radio 4’s Moneybox
Couples can save thousands of pounds in tax by using a little-used trick beloved of financial advisers – simply by switching their savings from one to the other.
The Telegraph’s new “switch your savings” calculator (see below) works out the optimum amount of money held in savings accounts to switch from the higher-earning partner to the lower earner. By doing so, one partner can end up paying no tax at all on their savings interest, while the higher earner can drastically cut their tax bill.
The switching trick is more important now because steeply rising interest rates means more people than ever are paying tax on their savings.
Over the past decade savings rates have been as low as 0.1pc, meaning there was almost no chance of earning enough to pay tax. But now anyone with modest savings may find the interest is enough to generate a tax bill. At 5pc interest rates, a higher-rate taxpayer would only need £10,000 in savings to fall into the tax net.
What most people don’t realise is that people on a low income can benefit from three exemptions from savings interest and, by exploiting those, a couple can save vast amounts of tax.
The ‘starter rate’ for savings
Where one partner has an income below £17,570 they can use a little-known exemption for savings interest which can give relief from tax for up to £5,000 of interest. This tax free band – called the Starter Rate for Savings – is worked out by subtracting taxable non-savings income from £17,570. If the difference is more than £5,000 then the tax-free band is £5,000. If it is less than £5,000 then that is the amount of the tax-free band. In this band tax on savings is 0pc.
Non taxpayers
If one partner has an income below the personal tax allowance of £12,570 the difference between this and their income can be added to tax-free savings allowances.
The savings allowance
All basic-rate, 20pc, taxpayers get a £1,000 savings tax allowance which exempts that much interest from attracting income tax. The allowance for higher-rate, 40pc, taxpayers is £500 but it is zero for people who pay the top rate, 45pc, of tax which is charged on income above £125,140 a year.
By exploiting these allowances – which can be used together – a couple with unequal incomes and large amounts of savings can avoid tax on the interest paid on more than £100,000 if one partner has a low enough income to qualify for the above exemptions. All a couple has to do is transfer some or all of the savings to the lower-earning partner.
How to do it
Example 1: two low earners
For example, Winifred, 75, has her state pension of £161 a week plus a pension from her job of £219 a month making an annual income of £11,000. She has £8,000 of savings from an aunt who died which earns 5pc in a savings account. She pays no income tax as her total income is below the personal allowance of £12,570.
Her husband Thomas has a higher income. His state pension is £200 a week and pensions from his old employers total £2,883 a month making a total income of £45,000 a year. He has £100,000 savings which also earns 5pc giving him £5,000 a year savings interest. He gets the £1,000 personal savings allowance so he is taxed on £4,000 interest at the basic rate which is £800. That is taken from his company pension by reducing his tax code.
If Thomas gives £80,000 of his savings to Winifred his remaining £20,000 at 5pc earns him just £1,000 which is covered by his £1,000 personal savings allowance so he pays no tax, saving him £800 a year.
Winifred has three tax allowances against her savings.
First, her income is £11,000 leaving £1,570 of her personal allowance. Secondly, her income is below £17,570 so she gets the full nil-rate savings band of £5,000 and she can have the £1,000 personal savings allowance as well, making a total of £7,570 interest tax free.
So when Thomas gives her £80,000 of savings on top of her own £8,000 that will earn £4,400 in interest, well short of her allowances. By giving his wife £80,000 of savings neither pays tax on the interest from a total of £108,000 savings.
How to do it
Example 2: two middle earners
Their neighbours Anna and Steve are younger and work. They can save even more tax. Steve has an income of £60,000 a year and so pays higher-rate tax. He earns £5,000 at 5pc from his savings of £100,000 and after the £500 personal savings allowance he pays £1,800 in tax.
Anna has a part-time job earning £15,000 a year and also has £8,000 in savings. She has no personal allowance left over but she does have a starter savings rate of £2,570 (£17,570 minus her £15,000 salary). On top of that is her £1,000 personal savings allowance. So she can earn a total of £3,570 in interest without paying any tax and at 5pc interest she could have £71,400 savings before tax was due on the interest.
Steve uses the Telegraph’s calculator (above) which says he should transfer £63,400 of his savings to Anna. That leaves him with £36,600 which earns £1,830 in interest. The tax on that after his £500 personal savings allowance is just £532. Anna now has £71,400 in savings which at 5pc interest brings her £3,570. That is perfectly covered by her two savings allowances meaning she pays no tax on it. So Steve has saved £1,268 off his tax bill.
The calculator is only a guide and works best for standard cases where the richer partner has a taxable income, before savings interest, below £100,000 and the poorer partner does not pay higher-rate tax.
The biggest savings are made if that partner’s income is below £17,570. But there are still savings to be made at higher incomes. If Anna earned £42,000 Steve could still save £240 tax by giving her £12,000 of his savings.
How to do it
Example 3: two high earners
Those on much higher incomes can benefit as well. Generally, the bigger the income differential between the partners, the bigger the savings.
Malcolm runs a local factory and earns £160,000 a year. Jenny does a little part-time work and is paid £100 a month. She pays no tax and has £20,000 in her savings account. She could have £131,400 of savings at 5pc before any tax was due on her interest.
Malcolm pays income tax at the top rate of 45pc. He has £100,000 in a savings account earning 5pc. Tax on that amounts to £2,250. But if he gives all his savings to Jenny she would still pay no tax and nor would he, saving the entire £2,250 tax due.
In an extreme example, where a top-rate paying partner had £1m in savings earning 5pc and their partner had no income or savings at all, transferring £371,400 could generate savings of £8,350.
A note of caution. The calculator may not give completely accurate answers where switching savings takes an individual’s income across a tax threshold or above £100,000 where the personal allowance is tapered away. It also ignores dividends which may affect the tax band the individual is in.
Remember, the cash gift to your partner must have no strings attached so they own the money transferred to them. No income or capital gains tax is due on the gift whether you are married, in a civil partnership, or just living in non-marital bliss.
However, if you are not married or civil partnered then gifts totalling over £3,000 in a tax year may create an inheritance tax charge if the donor dies within seven years of making the gift.
Good news if you live in Scotland – the rules, thresholds, and calculations are the same for you as in the rest of the UK.