Tax might not be an issue that many people think about when they open a savings account, but it is important to be aware of how much tax you are paying, and whether you need to be paying it at all.
If you are on a relatively low income and have funds in a bank or building society savings account, you could be paying tax when you don't need to.
Read on to find out more about how the system works, and how you could make it work to your advantage.
How savings taxes work
If you hold a savings account with a bank or building society, any interest you earn on the funds you invest is effectively classed as income, and is therefore taxable.
The interest you receive is added to your other income and taxed after tax-free allowances, such as the basic personal allowance, have been taken into account.
Most people will see a fifth (20 per cent) of their interest earnings go the taxman. Savers on the higher tax rate (who earn between £31,866 and £150,000 a year) pay 40 per cent, while additional-rate payers (earning more than £150,000 a year) lose 45 per cent of their savings interest.
If your total taxable income is less than your tax-free personal allowance, you can register to receive untaxed savings interest and reclaim any sums you have paid without needing to.
Your personal allowance is the amount you can earn in a year before paying income tax.
Based on your age and your circumstances, it currently ranges from £10,000 to £10,660 a year.
If your income is only slightly higher than your personal allowance, meaning you pay a small amount of income tax, any interest you receive on savings might be taxable at a lower rate of ten per cent, known as the 'starting rate for savings'. You might be able to reclaim any tax that has been deducted at a higher rate in the past.
Registering and reclaiming
If you believe you are entitled to tax-free interest on your savings, you need to register with your bank or building society using the R85 form, which is available from HM Revenue & Customs (HMRC). It might also be possible to register by phone.
The HMRC website features an R85 tax-free interest checker, which could help you confirm if you are entitled to this benefit.
If you think you have paid too much tax on your savings interest in the past, there are procedures in place to help you reclaim it. Fill in an R40 form for each year you think you paid unnecessary tax, and the amounts paid should be returned to you.
The time limit for submitting your claim is four years from the end of the tax year in question. For instance, if you are claiming for payments made in the 2010-11 financial year, which ended on 5 April 2011, you have until 5 April 2015 to get the necessary documents to HMRC.
One of the easiest and most effective ways of saving substantial chunks of money each year without paying any tax at all is by using an individual savings account (ISA).
On 1 July 2014, Britain welcomed the new ISA (NISA), a change announced in this year's Budget. The NISA offers a number of benefits for savers, including an increase in the tax-free savings allowance from £11,880 to £15,000 each tax year.
Furthermore, consumers now have the flexibility to divide their savings between cash and stocks and shares accounts as they choose. Previously, the amount that could be invested in a cash ISA was capped at half of the overall annual allowance - £5,940.
There is no denying the benefits of ISAs, but the tax-free savings threshold means that people who are planning to save large amounts over the course of a year will need to find other accounts to invest in.
Regular savings accounts can offer attractive rates of interest for customers who are able to deposit certain amounts every month, while instant access accounts provide convenience for people who want to be able to withdraw money quickly and easily.
While interest is taxable on products such as these, they remain useful and potentially beneficial options for consumers working hard to put money away for the future.
The content published on this website is intended to provide information only. The reader should seek advice from experts on the subject matter and independently verify the accuracy and relevance of any information provided here before relying upon it or using it for any reason. You can view our terms and conditions here.