Is exceeding the U.K. Personal Savings Allowance - and being taxed - a bad move?

Question

I’m based in the U.K. and in 2022 inherited approx £370k

I did not have any debts, except a mortgage on my main and only home, which I paid off in full.

I made use of my full £20k ISA limit over the last two tax years. I contributed money to my SIPP (pension) and got tax relief on it.

I do not want to buy a second home. I was left with approx £100,000 some of which I put into interest-bearing accounts.

One such account was a 2 year fixed rate deal which paid 3.82% in interest at the end of the term (ie 2 years after the account was opened). This will generate £1528 in interest which is over the £1000 Personal Savings Allowance.

I’ve been given 2 different opinions by friends:

1. This is a bad move because I’ll be paying 20% tax on the £528 portion of interest that exceeds the PSA.
2. It’s fine, because being taxed as above still leaves me with more than if I hadn’t opened the account (e.g. left the initial £20,000 in an account that didn’t bear interest).

The view of it being a good move is essentially - you’re still better off generating the interest and paying tax than not doing.

My understanding of financial advice is you should minimise (within the law) the amount of tax you pay, which supports the “bad move” theory.

What are people’s views on this? Is it a good or bad move? Please note this is specific to the U.K. I am in full time employment and pay PAYE tax/national insurance at 20%.

Answer 1

It’s fine, because being taxed as above still leaves me with more than if I hadn’t opened the account (e.g. left the initial £20,000 in an account that didn’t bear interest).

This seems pretty clear-cut.

Would you take a pay cut of £528 in order to save the tax on that amount? If not why would you forgo interest voluntarily?

My understanding of financial advice is you should minimise (within the law) the amount of tax you pay, which supports the “bad move” theory.

I think this is a misunderstanding. Obviously paying less tax on the same income is better than paying more tax, unless you want to voluntarily give the government money. But reducing your income so you end up paying less tax but have less in your pocket makes no sense.

Answer 2

The goal cannot be to minimise your taxes, but to maximise what ends up in your pocket. If you wanted to minimise your taxes, you'd give all your money to charity and have nothing left. That's not what you want.

If you get 3.82% interest, then the first £1,000, that is the interest on £26,178 is tax free. Above that, since you pay 20% taxes and get to keep only 80% of that interest, your interest rate goes effectively down to 80% of 3.82% = 3.056% interest for any money above £26,178. A lot better than nothing.

Answer 3

Some great answers here already, you are returning interest on the money (so don't let that dishearten you!) but it is being skimmed off by tax - what others may propose is to ultimately invest excess money in ways that either make use of other tax allowances or are themselves assets that reduce other costs or appreciate over time attracting more money at point of sale.

In my case I purchased solar and battery storage for my property, going on the theory that electricity rates will increase in the next 20 years (and the micro-inverters are warantied for that period and the panels for 40 years) that reducing my post-tax electricity costs (themselves a cost of living tax on my income) was a good use of the money - the solar also produces income itself which under current UK tax law is not taxable - so an untaxable additional revenue stream. You'd have to run your own numbers and decide whether you're wanting a solar setup purely for money or see other advantages that mean money is not the primary factor. RoI (and a bit of energy price crystal ball forecasting) is a huge factor too, there are some systems that will never make a return (probably mine, I over-spec'd the quality and number of panels and batteries). You do have to consider if you'll move throughout the life of the installation also.

Others may choose to mess about with shares and receive the interest via dividends (up to £1k a year - another tax allowance).. of course this backfires if the company fails to perform better than the post-tax interest rate in your savings would otherwise afford you. I also participate in my employer's share incentive plan - which means the shares are purchased pre-tax instead of me being paid and then if I sell them after a period of time they do not attract tax either. The shares can lose some value when I go to sell them and the returns can be slightly poorer than bank interest and I will still be better off than having been taxed on each pound at source.

Then there's salary sacrifice for items not attracting Benefit in Kind (BiK) tax, you could tell your employer to buy you a Tesla instead of paying a portion of your salary which would allow you to purchase the Tesla (or any EV) pre-tax (which for higher rate tax payers is a 40% discount). Making even more use of your income pre-tax. While you have the cash already in your account this may seem irrelevant, but I suggest it as you could live off your savings and instead sacrifice other income for tax efficient purchases at great discount.

The more traditional way is as you identified, people just invest in a property and hope the property value grows from that beyond the post-tax interest they would otherwise make - that in its own way is the same as dabbling in the stock market. There's more taxes on additional properties to make this not always work out. Also the threshold/allowance for the Rent a Room scheme has not increased as much as inflation and has been the same since 2016! - so lodger/rental income above £7.5k still attracts tax and would be easily hit with a £625pm rental.

Most of these methods assume inflation will be positive and whatever you buy upfront now is cheaper than trying to buy it later and whatever you sell in future could be worth more than what you're buying it for today.

Would not underestimate the effort of managing or dealing with these things also, there's nothing wrong with deciding that the tax you pay on the interest is the path of least resistance and your time has more value than exploring all these means of tax efficiency. Interest rates are also widely predicted to fall in the near future.

Might also be worth considering asking a professional advisor beyond Stack Exchange.

Answer 4

Your goal is to maximise your after-tax income, which is not the same as minimising the tax you have to pay. All else being equal earning interest and paying tax on it is generally better than not earning interest in the first place.

If it was the only interest-bearing account you had, then an account that paid out zero in one year and roughly £1500 in the next year would be worse than an account with the same interest rate that paid interest annually because you would be wasting your allowance in the first year.

On the other hand, if you have other accounts paying similar rates of interest (you don't say what you did with the rest of the £100K) then this may not matter as you may be meeting the threshold every year anyway.

Answer 5

I have not done the calculation but it might be bad if the income increases your total income to the point that you are in a higher tax bracket.