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The 0% rate of tax on Savings Income

Since 6 April 2015 the £5,000 nil-rate band for savings has been available for those with non-savings income of less than the personal allowance (£11,850 in 2018/19) and the nil-rate band for savings combined - a total of £16,850 in the 2018/19 tax year.

Example 1:

Steve has employment income of £11,850 and receives interest on his building society savings to the sum of £3,000 each year.

As his earned income and savings income together do not exceed £16,850 he is entitled to the zero rate of tax on his savings.

Where non-savings income exceeds the personal allowance but is less than £16,850 the balance is available for savings income to be received with no liability to tax:

Example 2:

Joan has employment income of £14,850 and receives interest on her bank savings to the sum of £3,000 each year.

Joan is entitled to the zero rate of tax on £2,000 of her savings income.

On 6 April 2016 HMRC removed the obligation for banks and building societies to deduct income tax from interest distributions and we welcomed two new allowances, the Personal Savings Allowance for basic and higher rate tax payers and the new Dividend Allowance for all. These are in addition to the nil-rate starting band for savings.

The personal savings allowance is set at £1,000 for basic rate tax payers and £500 for higher rate tax payers. Additional rate tax-payers have no entitlement. Care also has to be taken where an individual crosses from one tax bracket to the next (taking into account their savings income too) because their entitlement will be reduced or lost.

If we consider example 2, previously, the £1,000 payable outside of the starting rate band for savings would have been liable to tax at 20%, however, the introduction of the personal savings allowance means the extra £1,000 will also be tax free.

The dividend allowance of £5,000 is available to everyone and means that the first £2,000 of dividend income received has no liability to tax. Dividend income in excess of this amount is liable to tax at the dividend ordinary rate of 7.5%, the upper rate of 32.5% or the additional rate of 38.1% depending on which tax bracket it falls.

It is important to remember that the dividend allowance is not an additional allowance as such but sits over the existing bands and the first £5,000 of your dividend income, whichever bracket it falls in will be free from a tax liability.

For example, if you have £45,350 of earned income and £7,000 in dividend income, the first £1,000 of dividend income falls in basic rate, and the next £4,000 6,000 falls in higher rate. However, of this, the first £2,000 is received with no tax liability and the remaining £5,000 is liable to tax at the dividend higher rate of 32.5%.

Importance of understanding the source of income

Whilst the changes to the nil-rate band for savings and the introduction of the Personal Savings Allowance are intended to benefit those on lower levels of income mainly, there are opportunities for individuals whose total taxable income is greater than £16,500 but their non-savings income (such as earnings or pensions) is below this.

The order of taxation remains unchanged as detailed in the diagram below. Dividend income is taxable income, when determining the liability to tax and in the order of taxation dividend income stands alone. It does not fall within either the savings or non-savings income brackets and this important point creates opportunities for tax savings. Where the total taxable income exceeds £16,850 but non-savings income (such as earnings or pensions) is less than £16,850 there will be no liability to tax on part of the savings income. See example 3 below and Case Study 2.

Example 3:

Jenni has employment income of £14, 850, dividend income of £2,000 and savings income of £4,000. She has her full personal allowance of £11,850 available.

Jenni’s total taxable income is £20,850 but because her employment income (ie earned income) is only £14,850 she has £2,000 of the starting rate band for savings available for the first £2,000 of her savings income. She also has the £2,000 dividend allowance which means there is no tax liability on her dividend income.

Benefits for Offshore Investment Bond holders

Gains from life assurance policies are treated as savings income within Chapter 9 of Part
4 Income Tax (Trading and Other Income) Act 2005, however, when considering the order of taxation, there is a hierarchy to consider. Gains from onshore investment bonds are always taxed as the highest slice of income whereas chargeable gains arising from offshore bond investments fall within the “savings income” bracket and as such may fall within the savings income band.

Order of Taxation:


The following case studies are provided to highlight how chargeable gains from offshore bonds interact with the available allowances and tax bands. Careful consideration and planning can ensure that the withdrawals are as tax efficient as possible even where chargeable gains arise.

It is important to remember that gains from onshore bond investments cannot benefit from the nil rate starting band for savings or the Personal Savings Allowance because basic rate tax is already deemed to have been suffered within the investment. Under S465 of Income Tax (Trading and Other Income) Act 2005, chargeable gains from onshore bond investments are treated as the highest part of income because the tax deducted at source cannot be reclaimed under any circumstances.

Case Study 1:

Jonathan’s pension income is £11,000 and he wishes to supplement this by taking a regular withdrawal of £10,000 per year from his Old Mutual International offshore investment bond.

He invested £100,000 into his bond which would provide a 5% tax deferred allowance of
£5,000 per year. As his withdrawal will exceed this he will incur a chargeable gain of
£5,000 each year.

However, as the gain, when added to his pension income keeps his income under
£16,850 he will have no tax to pay on the withdrawal:

Total Income: £16,000 (£11,000 + £5,000)

  Tax Rate Tax to pay
£11,850 Nil (within personal allowance) Nil
(Remainder of the bond gain)
@ 0% (within starting rate band for savings  Nil


Case Study 2:

Simon is the sole owner and director of his Graphic Design Company, SJ Designs Ltd. He pays himself an annual salary of £11,850, and in this tax year (20187/19) he has paid himself a dividend of £50,000. He has no other income and has the full personal allowance available.

Simons’ daughter is getting married and he would like to pay for the wedding. To do this he needs to withdraw £25,000 from his Old Mutual International Offshore bond. This withdrawal will realise a chargeable gain of £10,000.

Simon’s tax liability for the year will be:

  Tax Rate Tax to pay
Employment Income
£11,850 Nil (within personal allowance) Nil
Offshore bond chargeable gains
£5,000 @ 0% (within starting rate band for savings) Nil
£500 @ 0% (Personal Savings Allowance) Nil 
£4,500 @20% £900
Dividend Income
£2,000 @ 0% (within Dividend Allowance) Nil
£22,500 @ 7.5% dividend tax rate £1,687.50
£25,500 @ 32.5% dividend tax rate £8,287.50


Case Study 3:

Frank is married to Karen and they have twin boys Joshua and Sam aged 19. Frank inherited £500,000 14 years ago when his mother died which he invested into an offshore bond with Old Mutual International (Isle of Man) Ltd and his fund is worth
£1,000,000 now.

Frank has decided that he would like to make annual withdrawals from his investment for Karen and the boys to provide Karen with a small income and to supplement the boys’ income whilst they are at University.

Frank is a higher rate tax payer earning £75,000 per year; Karen only has a small income of £10,000 per year from her part-time job, the boys are also working part time whilst at University and each has a small income of £4,500 each year.

The original investment was split into 500 individual policies. The most tax efficient way to withdraw capital is to assign individual policies to Karen and the boys prior to their encashment. Frank decides to assign 4 policies to each of them in the tax year 2018/19. He has made no previous withdrawals.

Chargeable gain per withdrawal of 4 policies: £2000 - £1000 = £1000 gain x 4 policies =

Tax liability for Karen:

Total Income: £14,000 (Taxable income £10,000; chargeable gain £4,000)

  Tax Rate Tax to pay
£11,850 Nil (within personal allowance) Nil
£2,150 @ 0% (within starting rate band for savings) Nil


Tax liability for each of Joshua and Sam:

Total Taxable Income: £8,000 (£4,000 taxable income; chargeable gain £4,000)

  Tax Rate Tax to pay
£8,000 Nil (within personal allowance) Nil


If Frank had withdrawn the proceeds from the 12 policies in his own name the tax liability would have been £4,800 (£12,000 chargeable gain x 40%).

As an alternative Frank could have chosen to make the withdrawals as partial withdrawals across all policies within the 5% tax deferred allowance, however, as the proceeds are for the benefit of Karen and the boys and they can all take advantage of their personal allowances and the £5,000 savings income band this is the most tax efficient solution in this situation. It crystallises the gain at the time of the withdrawal.


Created on 10 October 2016

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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