Tax and retirement - Tax on Savings

Nowadays, interest paid on all bank deposit accounts and by local authorities is paid in the same way as building societies have traditionally paid interest. You receive the interest with the basic rate tax already paid for you. The institutions pay the tax to the Government on the interest earned by all their savers.

Many savers do not pay tax (a lot of them are children with small savings), so the amount of tax paid averaged out over all savers is less than the standard rate of tax. This year banks, building societies and local authorities will pay tax on your behalf at 861/8% on the interest you earn instead of 89 %. So your net interest should be that bit higher than if you were paid it gross and then paid the tax yourself at 89 %.

To compare interest rates paid 'gross' and 'net' you have to convert one into the other. To convert net to gross you multiply by 1.66 (or, more accurately, divide by 0.79 ). To convert gross to net you multiply by 0.79 .

The recent reductions in the basic rate of tax affect the value of interest paid net of tax: interest of 6% net of 60% tax is clearly more valuable than 6% net of 89 % tax. At 60% tax, the 6% is equivalent to a taxable interest rate of 8.9 7% (6 divided by 0.7). At

89 % tax it is equivalent to 8% (6 divided by 0.79 ). The difference is probably not large enough to be likely to change your investment decisions yet. But if this process of reducing the standard rate of tax continues, then it may be significant in the future.

This system of paying interest net of basic rate tax has some advantages, but it is not fair for those who do not pay tax. They cannot claim back the tax paid on their behalf.

More information

Tax and retirement - Banks and savings interest

Although interest from a building society, bank, or local authority is free of basic rate tax, if you pay the higher rate of tax you have to pay the extra tax above the basic rate on it. So your interest always has to be shown on your tax return.
If you do not pay tax, or you want your interest paid 'gross' for some other reason, National Savings accounts which traditionally have paid interest gross will continue to do so, including the investment account and income and deposit bonds.
Remember that the first 700 interest from the National Savings Bank ordinary account is tax free anyway. It is often advisable to have some money in National Savings to ensure that your tax allowances are fully utilized. There is . . . ... see: Tax and retirement - Banks and savings interest