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How to keep your savings tax efficient

POSTED: 1st July 2014
IN: Personal Guides
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Tax - one of only two certainties in life, so the saying goes. There is no escaping from the fact that we have to pay tax, but there are things we can do to reduce the burden on our finances.

Tax - one of only two certainties in life, so the saying goes. There is no escaping from the fact that we have to pay tax, but there are things we can do to reduce the burden on our finances. undefined

This is particularly true for savers. The government relies on the taxes we pay, but it also has a responsibility to promote financial prudence and preparing for the future, so there are various benefits and forms of tax relief available to encourage saving.

So what are the best ways to ensure we are not paying any unnecessary tax?

General savings

On bank and building society savings accounts, the government deducts tax from any interest earned before it is paid to the customer. Normally, 20 per cent of the overall interest goes to the taxman, but this rises to as much as 45 per cent for higher-rate taxpayers.

However, you can register to receive interest without tax deductions, on the condition that your income is below the tax threshold, meaning you don't normally pay income tax. For the 2014-15 financial year, the threshold ranges from £10,000 to £10,660, depending on your date of birth and your overall income in the tax year.

If you are on a low income, you could be entitled to pay only ten per cent tax on your savings interest. According to a report published by the Telegraph last year, up to 3.5 million people - many of them pensioners - could be due a refund after paying too much tax. 

The Low Incomes Tax Reform Group urged pensioners and other people on low incomes to contact their bank and their tax office to check how much they should be paying. Chairman Anthony Thomas said: "As interest rates continue to be at a historic low, savers need to count every penny."

Low earners can register to receive tax-free savings interest by filling in HM Revenue & Customs' (HMRC) R85 form, while those seeking a refund should complete form R40.

For general savers, the best way to put money away without paying tax on the interest is through an ISA, or a NISA, as these products will be known from 1 July 2014. From that date, the annual tax-free savings allowance will be £15,000, which can be divided between cash and stocks and shares accounts in any way you choose. Previously, savers could only save up to half of their annual allowance in cash.

NISA customers pay no income tax on interest or dividends they receive, and any profits from investments are exempt from capital gains tax.

Children's savings

People with children born between 1 September 2002 and 2 January 2011 should take advantage of the fact that their child is eligible for a child trust fund (CTF). These products offer tax-efficient savings, with no tax paid on any income or gains in the account until the child turns 18. The money invested in the fund cannot be taken out until that time.

Parents, family and friends can make contributions to the fund every year. The overall amount that can be invested is capped at £3,840 for the 2014-15 tax year. CTFs came with one-off starter payments of £250 or £50 from the government, depending on the child's date of birth.

The CTF was replaced by the junior ISA, which also allows tax-free savings of £3,840 a year. Like adult products, junior ISAs offer a choice of cash or stocks and shares investments, or a combination of the two.

Parents who are interested in the ideological as well as financial benefits of preparing for the future could consider opening a regular savings account for their child. Unlike ISAs and trust funds, these products offer easier access and allow greater involvement on the part of the child, meaning they can help to teach financial awareness and good savings habits. Just like with the adult version, registering an R85 form on a child's savings account will ensure tax on interest earned is not deducted at source.

Pensions

The government offers tax relief on pension contributions to encourage workers to save for retirement, so it is important to make the most of the allowances on offer.

If you are on an occupational pension scheme, payments are usually taken from your wages before tax, meaning you instantly get the full amount of relief available. If, for some reason, your employer can't deduct your pension contributions, you can still claim tax relief by completing a tax return or contacting HMRC.

For every £80 paid into a personal pension, you should receive £100 in your pension pot. This is because you pay income tax before any pension contributions, and your provider reclaims tax from the government at the basic rate of 20 per cent. Higher-rate taxpayers can ensure they receive the same benefit by contacting HMRC, while additional-rate payers have to claim the difference through their tax return.

Pensions come with many other tax benefits, such as tax-free growth in your overall fund, with the exception of a ten per cent deduction from dividend income. Furthermore, retirees can usually take up to a quarter of their pension pot as a tax-free lump sum.

Some people might see retirement planning as a difficult subject to broach, but the sooner you start making preparations for your long-term financial future, the bigger the benefits.

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