Richard Curtis provides an overview of how interest and dividends are taxed on individuals.
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It might be thought that the taxation of interest and dividends should be fairly straightforward, but changing rates and particular rules and exemptions have somewhat muddied the waters.
This article briefly looks at the taxation of such savings income, but if this might also fall within the scope of income from employment or from a trade or profession, the rules of assessment applying to those sources will apply in priority.
Out of interest…
Many individuals will receive interest from banks, building societies or other sources and tax may sometimes be deducted at source. Income tax is charged on the full amount of interest for the tax year, whether this is from a UK or non-UK source.
The main rates of income tax – the 20% basic rate, 40% higher rate and 45% additional rate - apply to taxable interest, but taxpayers may be entitled to a personal savings allowance (PSA) and interest up to that amount is not subject to tax. The allowance is £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Those subject to additional rate tax are not entitled to the PSA. Although termed an allowance, the PSA is, in fact, a nil-rate band of the above amounts.
There is also a 0% starting rate for savings of up to £5,000 which applies to as much of the first £5,000 of taxed income that is savings income. As the personal allowance (the amount that can be deducted from income generally) is £12,570, the threshold for benefitting from the 0% band is £17,570. If income other than savings income is less than £12,570, the full £5,000 zero rate will be available in full. If other income exceeds £17,570, no zero-rate band is available.
For example, Mr Smith has employment income of £14,000, and bank interest of £2,500. The personal allowance of £12,570 is deducted first from the employment income, leaving £1,430 taxable at 20%. This also reduces the £5,000 savings rate by £1,430, but the interest received of £2,500 is less than the remaining £3,570, so it is all taxable at the zero rate.
Dividends received
Dividends are paid by companies and must be paid from income subject to corporation tax. As with the PSA for savings and investment income, there is a dividend allowance. When first introduced in 2016/17 the allowance was £5,000, but over the intervening years this has been reduced, and for the current year 2024/25 it is £500.
Because dividends can only be paid by companies from income that has been subject to corporation tax, for many years that corporation tax was treated as a basic rate tax credit, so dividend income would only be subject to income tax if the taxpayer was liable at a higher rate. Now, however, dividend income that exceeds the dividend allowance is taxed at 8.75% for basic rate taxpayers (the dividend ordinary rate), 33.75% to the extent that the dividend income falls within the higher rate band (the dividend higher rate) and 39.35% if more than the higher rate limit (the dividend additional rate). Unlike the PSA, the full dividend allowance is not reduced for higher and additional rate taxpayers.
Applicable tax rates
As can be seen from above, the tax charged on interest and dividends will depend on the amounts received and the level of other income. After the deduction of the personal allowance, the PSA and the dividend allowance (and taking into account the savings nil-rate band) and any other allowances or deductions, the amount of the remaining chargeable income will determine the extent to which it falls within the basic, higher and additional tax bands. These bands will apply first to income from employment and self-employment, then to interest and finally to dividend income. This is a generalisation and if the taxpayer has other sources of income, detailed advice should be obtained.
Practical tip
Each individual is potentially entitled to a personal allowance, personal savings allowance and dividend allowance. Married couples might consider transferring accounts or shareholdings that yield interest or dividends to maximise the benefit of those allowances or reduce the tax charged. As always, tax is not the only factor to be taken into account.
