In the past, when you opened a savings account, you decided between gross or net savings interest. Gross means you get all of the savings interest while net means you have to pay some tax on what you earn.
Now, the new Personal Savings Allowance means that most of us won’t pay tax on savings interest. But what if this changes in the future? Do you know what the terms ‘gross savings interest’ and ‘net savings interest’ mean? Let’s take a look at the terms.
Gross or net?
If a savings account says it offers 2% gross savings interest in a year, you know that you’ll get 2% extra on everything you save. So for example, if you save £100, you’ll have £102 at the end of the year.
All savings accounts now pay a gross rate of interest for the first £1,000 of savings interest you earn each year. This is thanks to the new Personal Savings Allowance and it means that most savers don’t pay any income tax on their savings interest anymore.
But if you do have more than the Personal Savings Allowance, your savings will earn interest in a slightly different way. Anything over the limit will earn net savings interest – this means you pay income tax on it.
As a real life example, let’s say you had £60,000 saved in a 2% saving account and you’re a basic rate taxpayer. For the first £50,000, you’d pay no tax because you’d earn £1,000 of savings interest. This takes you up to the limit of your Personal Savings Allowance. For the leftover £10,000, you’d pay tax on the savings interest. This means instead of earning £200, you’d actually only earn £160.
Don’t worry if you find this confusing. As we said above, the Personal Savings Allowance means you probably won’t pay tax on your savings unless you’re saving a lot of money. Net savings interest doesn’t really matter to you – at least for now.
Will things change?
You might not pay any tax on your savings interest at the moment, but will this always be the case? Interest rates are currently low but when the Bank of England base rate starts to rise, savings account rates are likely to go up too.
So if this happened and you had a savings account paying 8%, you’d only need £12,500 to reach the Personal Savings Allowance. Anything over this amount would earn net savings interest instead of gross savings interest.
That’s why you might think about saving your cash in an ISA instead. These accounts always pay gross savings interest because you don’t pay any tax on your savings interest. This means they could be a better option if interest rates start to rise.