The tax-free Personal Savings Allowance (PSA) was introduced in April, meaning you can now earn tax-free interest not only from ISAs but from savings accounts and current accounts too. But what are the tax implications for current account rewards such as cashback and switching bonuses?
Here are the facts when it comes to income tax on everything from interest to cashback to reward payments.What comes under the Personal Savings Allowance?
Since April 2016, basic rate taxpayers have been allowed to earn up to pound;1,000 in savings income tax-free, while higher-rate taxpayers get a pound;500 allowance. This is all on top of the annual ISA allowance.
But HMRC says not all payments made by banks and building societies are savings income, so would not necessarily fall under the Personal Savings Allowance.
According to HMRC guidance, if you receive annual payments that are non-interest then the basic rate tax will be deducted at source. If an individual is not liable to tax they can reclaim any tax deducted by completing an R40 form or on their self-assessment tax return.
If you are a higher-rate taxpayer you would need to pay the extra amount through your tax return.
An HMRC spokesman told us: In general HMRC would only expect the payments to be annual payments if they can continue for more than a year and the customer does not pay a fee for holding the account.
This means that one-off payments or monthly payments that last less than a year are not annual payments. Because annual payments are not covered by the PSA, banks and building societies will continue to pay them with basic tax deducted.
But even if your rewards are not annual, you could still be taxed if you get monthly cash rewards as these may fall under the HMRC definition of miscellaneous payments.
This creates more admin and confusion as miscellaneous payments dont have tax automatically deducted, so basic and higher rate taxpayers would have to disclose this on a self-assessment form.
So which products are really tax-free?Savings accounts
Lets start with a relatively straightforward one. All savings interest up to pound;1,000 for basic rate taxpayers and pound;500 on the higher rate falls under the PSA. Anyone earning above the threshold would need to complete a self-assessment tax return.Current accounts
Any interest you earn on current accounts would come under the PSA.
So for example you could open TSBs Classic Plus Account paying 5% on balances up to pound;2,000, or a Santander 123 Current Account and get up to 3% on balances between pound;3,000 and pound;20,000 tax-free as long as your income from all bank accounts is below the Personal Savings Allowance.
Several banks and building societies offer cash incentives for people switching their accounts. This is considered a discount so wouldnt be taxed, according to Moneyfacts.
Additionally, some providers will offer you cashback or rewards on certain types of spend. As these are also classified as a discount they arent taxed.
It gets confusing when a current account makes regular cash payments as these can be treated as annual or miscellaneous payments, so they would be subject to tax. For example, Halifax offers a well-publicised pound;5 reward on its Reward Current Account for each month you have two direct debits set up and pay in a minimum of pound;750 or more.
The reward is actually worth pound;6.25 a month, its just that the taxman has already taken a 20% cut before it arrives in your account.
Barclays has a similar offer on its Blue Rewards Current Account, except the taxmans cut has not yet been taken.
Customers can receive certain monthly monetary awards such as pound;7 for banking regularly and up to pound;3 a month for taking out its own protection products.
The pound;7 is liable for income tax, meaning you only actually get pound;5.60 a month. Strangely, the other rewards are not subject to income tax.
Ultimately you will need to check the terms and conditions of the current account, just to be 100% sure.