Some people will now be able to have up to £17,000 of savings income tax-free as a result of the new £5,000 dividend allowance.
There are essentially three main categories of income, savings income: which includes interest on deposits in banks and building societies; dividends; and other income such as earnings, pensions and rent. Tax rates are applied to different types of income in a defined order and that order can make a difference to the amount of income tax payable. The order for taxing income is earning and other non-savings first, then savings income and finally dividends.
0% rate band
The 0% starting rate of tax operates in a very specific way but it can be valuable. The maximum 0% starting rate band is £5,000 and is given on your savings income if non-savings income is no more than the personal allowance of £11,000. However, as non-savings income is taxed first, it will not be available at all if your non-savings income exceeds the personal allowance plus the £5,000 starting rate band – that is a total of £16,000. So if you have earnings / pensions income of up to £11,000, you could receive £5,000 of savings income free of income tax.
Dividend income does not affect your entitlement to the savings income starting rate band because it sits on top of the savings income and is taxed last under the rules set out above. So you might have £11,000 of earnings, £5,000 of savings income and thousands of pounds of dividend income, but you would still qualify for the nil starting rate band and that would mean your £5,000 of savings income would continue to be taxed at nil.
There is also the new savings allowance. For basic rate taxpayers, it means that £1,000 of savings income will be tax free. Basic rate taxpayers could therefore potentially receive tax-free savings income of £17,000 (i,e, £11,000 personal allowance plus £5,000 taxed at 0% starting rate plus £1,000 savings income allowance). For higher rate taxpayers the savings allowance is reduced to £500, so the value of the tax relief given by the allowance is the same whether you are a 20% taxpayer or a 40% taxpayer. But if you have enough income to push you into the 45% tax bracket – even by just a pound – you lose the allowance altogether.
Spread the income
Basic rate tax is no longer deducted at source from interest on bank and building society accounts, etc. In addition, from April this year, the first £5,000 of a person’s dividend income is tax free. So it makes sense to ensure that dividend income is spread around a family – where possible – to maximise the benefits.
If a couple find that one of them has a relatively low level of earnings/pensions, the lower income partner should consider holding the assets that generate the savings income and dividends to qualify for the extra -free cashflow.
Children under 18 – and sometimes even older – generally have relatively low earnings or other non-savings income. Any tax-free savings or dividend income they receive could be really tax-efficient. But don’t forget, income that arises from a parental gift will be taxable on the parent if it comes to over £100 in a tax year.