## What is savings interest?

It is money you earn in return for holding your savings in an account. The amount of interest you earn is set by the rate offered by your savings account.

For example, if you have £1,000 in a 1 year fixed bond paying at rate of 2%, the savings interest you earn will be £20 over the year (2% of £1,000 = £20).

There are many things that affect the amount of interest your savings account will pay, such as:

• The level of access

• How often interest is paid out

• How much you can pay in

• Competition in the marketplace

• If it is taxable

## How does interest work?

A savings interest rate shows what you get for a whole year and can be shown in one of the following ways:

• Gross interest: this shows what interest you would make on your savings before tax.

• Net interest: this shows how much interest you would make after tax. The amount of tax deducted from the gross figure is always 20%.

### What is AER?

This is the actual interest you could earn before tax, including compound interest and stands for Annual Equivalent Rate.

If you are a higher (40%) or additional rate (45%) taxpayer you need to pay your extra tax as part of your annual tax return.

The AER for monthly interest is lower than the gross interest rate because it does not include compound interest.

### What types of interest are there?

• Compound interest: This is when you earn interest on the interest you have already received from your savings. You lose this if your interest is paid into another account.

• Annual interest: This is when your interest is paid once a year; either on a set date or on the maturity date of the account.

• Monthly interest: This is when you have your interest paid on a monthly basis. This method may work well if you want to receive your savings interest as a regular source of income.

This table shows the difference between the interest you would earn on £5,000 over 5 years if you chose to compound interest or have your interest paid to another account:

Timescale Compound interest paid annuallyInterest paid out annuallyInterest difference
After 1 year£150£150£0
After 2 years£154.50£150£4.50
After 3 years£159.14£150£9.14
After 4 years£163.91£150£13.91
After 5 years£168.83£150£18.83
Total interest paid£796.37£750£46.37

Based on the table above, if you had your interest paid monthly you would have £12.50 paid to you each month.

When you get paid your interest monthly, your annual interest will be the same each year as long as the interest rate remains the same.

## Do you pay tax on savings?

Yes, but you do not need to pay tax on all of the interest you make on your savings if you qualify for a personal savings allowance or personal allowance.

If you earn under £17,000 a year you will not pay any tax on any savings interest.

### What is the personal savings allowance?

It is an allowance that lets you earn a set amount of interest from your savings without paying any tax.

• Basic rate taxpayers can earn £1,000 worth of interest before paying tax on their savings

• Higher rate taxpayers can earn £500 worth of interest before paying tax on their savings

• Additional rate taxpayers will not have a personal savings allowance

The personal savings allowance is in addition to any other allowance that you may be entitled to.

### What is the person allowance?

It lets you earn a set amount of money each tax year before you have to pay tax on your earnings, including your savings interest.

In the 2016/17 tax year, you have a personal allowance that lets you earn up to £11,000* without paying any tax.

* £11,500 from April 2017.

This table shows you how much tax you pay on your savings, excluding your personal allowance:

TaxpayerAnnual incomeTax deduction
Basic rateUp to £32,00020%
Higher rate£32,001 to £150,00040%

Alternatively, you can earn interest tax free by using your ISA allowance each tax year. Here is everything you need to know about saving with an ISA.

## How else can you save on savings tax?

You can also pay less tax if you qualify for one of the following:

### Annual savings allowance

This is an extra £5,000 tax free allowance for savings income. It is available to anyone who earns up to £15,600 (or £15,660 if over 75).

For example, if you are under 75 and have an annual income, including any savings interest, below £15,600 a year you will not have to pay any tax on your savings.

You could still get a partial tax refund if your savings interest pushes your annual income above £15,600.

### Marriage Allowance

This lets you transfer up to £1,100 of your personal allowance to your husband, wife or civil partner if your annual income is £9,900 or less.

You can apply for the Marriage Allowance if your partner has an annual income between £11,000 and £43,000.

### Married Couple's Allowance

This could reduce your tax bill by between £322 and £835.50 a year if either you or your partner was born before 6th April 1935.

Visit the GOV.UK. website to find out if you qualify for the Married Couple's Allowance.

### Blind Persons Allowance

This is a £2,290 tax free allowance on top of your personal allowance.

You can transfer this allowance to your spouse or civil partner if you do not earn enough of an income to benefit from the full allowance.

To qualify for the Blind Person's Allowance, you need to be registered with your local council as blind or severely sight impaired.