Since April 2016 banks have no longer deducted tax at source from interest paid on your savings. This is because 95% of bank customers can receive all their interest tax free thanks to a new savings allowance introduced in April 2016.
Previously pensioners and other people with modest incomes but significant interest income could benefit from a low starting savings rate for the first few thousand pounds of interest income. However most earners were disqualified from this benefit due to their higher income levels which exceeded the tax threshold. Now an extra tax free allowance of £1,000 has been introduced which applies to all basic rate taxpayers. This means that most working people can earn up to £1,000 interest tax free. Interest is now paid gross automatically by banks: the process in which form R85 was completed to claim the right to receive gross interest has been abolished. Higher rate taxpayers get a reduced tax free allowance of £500 while top rate taxpayers lose the tax free allowance entirely.
The savings starter rate is now 0% and applies to the first £5,000 of interest for people whose non-savings income does not exceed the personal allowance (£11,000 in 2016/17). However this allowance decreases by £1 for every £1 that the non-savings income exceeds the personal allowance. For example someone who earned a salary equal to the personal allowance but who received £6,000 in interest will benefit from the full £5,000 starter rate band, while someone earning £1,000 over the personal allowance will lose £1,000 from the starter band, being only entitled to £4,000 at the starter rate. The starter rate band is in addition to the £1,000 tax free interest allowance which applies to all basic rate taxpayers. Hence it is theoretically possible to earn up to £17,000 without paying any tax, if £11,000 is non-savings income (such as salary or trading profit), £5,000 is interest received tax free due to the savings starter rate and a further £1,000 interest income gains exemption from tax due to the extra tax free allowance which applies to all basic rate taxpayers.Below is a summary of the main rules governing the new tax free allowances: