Savings: how to make the most of tax breaks

Putting money aside for a rainy day is a great idea, but are you saving in the most tax-efficient way? Savers can benefit from a number of tax breaks and allowances, so make sure you're making the most of them.

Most people squirrel money away in a bank or building society savings account, but the income – or interest – you receive from your savings is not tax free. The tax you pay depends on the tax bracket you fall into based on your earned income, but most banks take 20%, the basic rate of income tax, from your interest before you get it.

If you are a higher-rate taxpayer, paying 40% tax, you must pay the additional 20% via a self-assessment form.

Depending on the interest you’re earning, savings accounts may not be the best place to put your money, and you should make sure you take advantage of these tax breaks:

Individual savings accounts (ISAs)

ISAs are the best way to save in the UK. You can save cash or invest in stocks and shares through them completely tax-free up to £10,680 for the tax year 2011/12. Note that only half of this amount, £5,340, can be saved in cash: the rest must be stocks and shares. Or you can invest the full amount in stocks and shares.

The allowance will increase to £11,280 from April 2012.

ISAs should be your first port of call for saving because, unlike savings accounts, they do not incur any income tax on the interest on cash and there is no capital gains tax to pay on profits from investments. You will also escape paying any additional tax on dividends paid out by investments above the initial 10%. 

Each person is entitled to one ISA, you must be over 18 to have a stocks and shares ISA or over 16 to have a cash ISA. You cannot have joint ISAs – they must be held in individual names.

Like savings accounts, ISAs offer different rates of interest, and the longer you tie your money in for the better the interest rate will be. If you want to be able to access your money easily then don’t expect a good interest rate.

You can use our ‘No Kickbacks’ savings tool to find the best cash ISA with the highest interest rate. It lists the top rates on the market for a range of different ISA accounts. We do not earn a penny from whichever ISA you go on to choose.

Junior ISAs

Junior ISAs are a tax efficient way to save money for children. The Junior ISA replaced the child trust fund in 2010 and much like the adult ISA, there are cash or stocks and shares options.