Combing starting rate for savings with dividend allowance

[JohnB]

I retired early part way through last tax year. HMRC sent a provisional 16-17 tax return predicting I had 6k of interest and 1k of dividends combined with actual 9k of salary. So total income 16k, but they say no tax liable, so I assume I was benefitting from the starting rate for savings, with allowances (11k(personal)+5k(srs)+1k(interest)+5k(dividends)=22k.

Their interest and dividend numbers are well out, I think when I do my actual return it will be 9k salary, 14k dividends, 3k interest=26k. Am I right that the calculation will go in the slice order, earnings,interest,dividends to give

No tax on earnings as 9k less than 11k
No tax on 3k of interest as 1k covered by interest allowance, and the remaining 2k by the 5k srs and 2k of personal allowance combined
But what about the 14k dividends. I have 5k dividend allowance, but how much personal allowance transfers, is it 2k, 5k or 7k?

For this tax year its likely to be no salary/pensions, 6k interest, 14k dividends.

The 6k interest will be covered by 1k interest+5k srs
The 14k dividends will have the 5k dividend allowance, but how much personal allowance will transfer, all 11k or part of it?

John

[pochisoldi]

For this tax year its likely to be no salary/pensions, 6k interest, 14k dividends.

The 6k interest will be covered by 1k interest+5k srs
The 14k dividends will have the 5k dividend allowance, but how much personal allowance will transfer, all 11k or part of it?

John

The starting rate for savings gets trampled on by any taxable non-savings income (the dividend allowance is actually a "nil rate band", not a "no tax band").
It's also my understanding that you have to lump earned/savings/dividend income together before you apply it against the personal allowance.

Then you need to look at the order in which you use your personal allowance

You have £20k of income, less £1k of savings income which is effectively tax free.

If you use your personal allowance for dividends first, you are left with 3k of dividends taxable at 7.5%, (leaving £2k of SRS+£1k savings allowance), and 20% tax on (6k-3k).
So the tax bill comes to £825.
You get to use some of the remaining SRS, but the 0% on first £5k of dividends is already covered by your personal allowance.

If you use your personal allowance for savings first, you have 6k of PA left to cover your dividends, and £5k of dividend allowance so you pay tax at 7.5% on 14k-6k-5k (=3k)
So the tax bill comes to £225.

For next year, the calculations come out as:
Dividends then savings - calculation unchanged (reduction in divi 0% band has no effect) £825
Savings then dividends - 7.5% tax on 14k-6k-2k (=6k), tax due £550.

PochiSoldi

[JohnB]

Thanks @pochisoldi. Further reading confirms SRS would not apply last year because 9k salary+14k dividends is more than 17k. You are forced to apply tax as 1) salary, 2) interest 3) dividends, you can't choose the order allowances are used, not that you'd want to as dividends are taxed less

9k salary tax free (all personal allowance)
3k interest tax free (2k personal allowance, 1k interest allowance)
5k of dividends tax free, 9k taxed at 7.5% = £675

For 17-18 with 14k dividends, 6k interest, 14k < 16.5k, so I'd have 2.5k of SRS allowance, but its no use, as I don't have enough interest

6k interest tax free (1k interest allowance, 5k of personal allowance)
11.5k of dividends tax free (6.5k of personal allowance + 5k dividend allowance)
2.5k of dividends taxed at 7.5%=£187 (slightly less than your 225, as I'm using the slightly higher personal allowance of 11.5k)

For 18-19 with 14k dividends, 6k interest, SRS no use again

6k interest tax free (1k interest allowance, 5k of personal allowance)
9k of dividends tax free (7k of personal allowance + 2k dividend allowance)
5k of dividends taxed at 7.5%=£375 (cf your 550, which I think was a typo for 450, again because I'm using the projected 12k personal allowance)

So it seems that to have any benefit from SRS I'd need my interest to climb above 12k while my dividends fell below 5k, which won't happen. Oh well.

Searching the web for tax calculators, virtually all assume you have a salary. Only Age UK allow you to enter dividends/interest only. http://www.ageuk.org.uk/money-matters/i ... calculator. They claim £525 for 16-17, but I think they've not added my dividends to my salary for the non-savings interest threshold, and £225 for 17-18, but again I'm a little suspicious

[greygymsock]

i disagree ... AIUI ...

taxable income falls into 3 categories:
1) non-savings (which includes salary)
2) savings (i.e. interest)
3) dividends

you are entitled to have your personal allowance (and any other allowances, e.g. blind person's allowance) applied against whichever of (1), (2) and (3), or whichever specific mixture of (1), (2) and (3), will give you the lowest income tax bill.

after the personal allowance has been used, the remaining income must be applied in the fixed order: (1) then (2) then (3). this determines to what extent you can use the £5k starting rate for savings, the £1k "personal savings allowance" for interest, and the £5k "dividend allowance". both the PSA and the DA are in fact zero-rate bands, not true allowances, which is why you have no choice about when to use them.

the choice about what income to set your allowances against has long been in the legislation, but it has only become relevant from 2016/17 onwards. before that, you could always get the lowest income tax charge by using the default order (i.e. (1) then (2) then (3)). but this is no longer the case, due to the interaction between the different allowances and bands.

so ... in 2016/17, with £9k non-savings income, £3k interest, £14k dividends:

the most favourable way to use the £11k personal allowance is to set all £9k of non-savings income + £2k of dividends against it.

that leaves you with £3k of interest and £12k of dividends, which must be taken in that order. the interest is (more than) covered by the starting rate for savings. £5k of dividends is covered by the DA. which leaves £7k of dividends taxable at 7.5%. tax bill = £525.

in 2017/18, with £6k interest and £14k of dividends:

the most favourable way to the use £11.5k personal allowance is to set £11.5k of dividends against it. (actually, that's joint most favourable - there are other equally good ways - any method which sets at least £9k of dividends against the personal allowance works.)

that leaves £6k of interest and £2.5k of dividends. £5k of interest is in the starting rate for savings, and the remaining £1k is covered by the PSA. the £2.5k of interest is (more than) covered by the DA. so no income tax due.

however, if you have the same position in 2018/19, the DA will be reduced to £2k. so if the personal allowance didn't increase, you'd have £0.5k of dividends taxable at 7.5%. but if the personal allowance increased by at least £0.5k, you'd have no tax due again.

apparently that i am agreeing with Age UK for 2016/17, but disagreeing with them for 2017/18. i don't know why.

[JohnB]

An interesting argument

For 2016-17, you get no SRS (salary+dividends>16k), I've stopped worrying about that one

For 2017-18 you suggest

the most favourable way to the use £11.5k personal allowance is to set £11.5k of dividends against it. (actually, that's joint most favourable - there are other equally good ways - any method which sets at least £9k of dividends against the personal allowance works.)

that leaves £6k of interest and £2.5k of dividends. £5k of interest is in the starting rate for savings, and the remaining £1k is covered by the PSA. the £2.5k of dividends is (more than) covered by the DA. so no income tax due.

The starting rate for savings is only 2.5k (its reduced so it plus dividends =16.5k), so there is 20% tax to pay on £2.5k of savings, ie £500, so you'd not opt for that route, but I can see that if dividends were lower, your interest tax would reduce too

For 2018-19 I'll aim to get more of my (p2p) interest into an IFISA. 14k dividends, 4k interest should be the tax free point (12k PA, 2k DA, 1k PSA, 3k SRS)

[JohnB]

PS I think the optimal pattern for 2016-17 is

£5k dividends, £17.5k interest (11.5k PA, 1k PSA, 5k DA 5k SRS)

Which you could get with a £120k index tracker and £200k p2p holding (and balls of steel for all that p2p)

[XFool]

i disagree ... AIUI ...

taxable income falls into 3 categories:
1) non-savings (which includes salary)
2) savings (i.e. interest)
3) dividends

you are entitled to have your personal allowance (and any other allowances, e.g. blind person's allowance) applied against whichever of (1), (2) and (3), or whichever specific mixture of (1), (2) and (3), will give you the lowest income tax bill.

So how do Tax Calculators (including HMRC's) ever work? Are they all programmed to minimise personal tax using the above method? What if some are and some are not? How do we know if they are or not?

How DO I work out my correct income tax? Should I look to hire time on a supercomputer?

[greygymsock]

For 2016-17, you get no SRS (salary+dividends>16k),

i can see where you may have got that from, but i still think it's wrong

e.g. this page - https://www.gov.uk/apply-tax-free-interest-on-savings - says: "You’re not eligible for the starting rate for savings if your other income is £16,500 or more" (16.5k because they're talking about 2017/18, not 2016/17). but i think that's sloppy wording: it's only correct if you read "other" income as "other than interest or dividends", not as "other than interest". other statements in the page talk about "earnings"; and it never mentions dividends explicitly.

IMHO, the implicit rule is: for 2016/17, you get no SRS if non-savings (i.e. neither interest nor dividends) income > 16k. but that's not an explicit rule, it's just implicit in the "order or taxation", viz. the principle that, (after setting your allowances against part of your income) the remaining income must be taken in the order (1) then (2) then (3) in order to see how it falls into the various tax bands (including the SRS).

for 2017/18 onwards, it is the same issue with different figures. (and you spotted correctly where i typed "interest" but meant "dividends".)

[greygymsock]

i disagree ... AIUI ...

taxable income falls into 3 categories:
1) non-savings (which includes salary)
2) savings (i.e. interest)
3) dividends

you are entitled to have your personal allowance (and any other allowances, e.g. blind person's allowance) applied against whichever of (1), (2) and (3), or whichever specific mixture of (1), (2) and (3), will give you the lowest income tax bill.

So how do Tax Calculators (including HMRC's) ever work? Are they all programmed to minimise personal tax using the above method? What if some are and some are not? How do we know if they are or not?

you may jest, but HMRC's calculator has got this wrong in some situations. see https://www.accountingweb.co.uk/tax/hmr ... per-filing ... i didn't mention that before, because AIUI the situations in which they get the tax calculation wrong are slightly different from JohnB's situation.

the way to know whether calculators work should involve somebody writing good tests for them.

i believe that, in all except 2 situations, the default method of setting allowances first against (1), and then (if any allowances haven't been used) against (2), and only then against (3), does minimize the income tax due.

1 of the 2 exceptional situations (the 1 which seems to apply to JohnB) is when the default method would set some allowances against (2), and that would result in some of the SRS or PSA remaining unused, and hence no tax being due on (2), but when there would then be some tax due on (3) (i.e. dividends not wholly covered by the DA).

in this case, the optimal solution is to reduce the amount of allowances set against (2), and correspondingly increase the amount set against (3), until either the SRS and PSA are fully utilized (so there is still no tax due on interest), or until there is no tax due on (3) (i.e. all dividends are covered by either allowances or the DA).

[JohnB]

With HMRC's Self Assessment calculator I got (using the actual numbers)

Code: Select all

Salary          £9,298.00
Interest        £3,624.00
Dividends       £14,257.00

Total income received              £27,179.00
minus Personal Allowance           £11,000.00
Total income on which tax is due   £16,179.00

Savings
Starting rate     £3,624.00 x 0%   £0.00
Nil rate          £0.00     x 0%   £0.00

Dividends
Nil rate          £5,000.00 x 0%   £0.00
Basic rate        £7,555.00 x 7.5% £566.62

Income Tax due £566.62

So salary covered by PA, all interest covered, and 5000+1702 of dividends covered, where 1702 is the residue of my PA after salary.

So it sounds you were right @greygymsock, well done! And I'm certainly not going to query a result in my favour.

[JohnB]

I entered the 0/6k/14k into the SA calculator and got no tax to pay. I then boosted the numbers to see what happened

Code: Select all

Salary          £0.00
Interest        £8000.00
Dividends       £18,000.00

Total income received              £26,000.00
minus Personal Allowance           £11,000.00
Total income on which tax is due   £15,000.00

Savings
Starting rate     £5,000.00 x 0%   £0.00
Nil rate          £1,000.00 x 0%   £0.00

Dividends
Nil rate          £5,000.00 x 0%   £0.00
Basic rate        £4,000.00 x 7.5% £300.00

Income Tax due £300.00


So it seems the SRS really is calculated on salary, not 'salary+dividends'. Interest deductions £5k SRS, £1k PSA, £2k PA. Dividend deductions £9k PA, £5k DA, leaving £4k to actually pay tax on.

I'm now cancelling all my Gift Aids, as I just won't be paying the tax I expected!

[chas49]

I'm now cancelling all my Gift Aids, as I just won't be paying the tax I expected!

Keep the Gift Aid on £1200 pa worth of donations though - if I've got this right, that amount of donations would attract £300 Gift Aid to the charities. The declaration you make says that you pay at least the same amount in tax as the total that all charities will reclaim on your donations in a year.

In the event you get the calculations wrong, you are responsible for paying the "back" tax - but I don't believe there's a duty to tell HMRC.. (a subject for a different topic though)

[gadgetmind]

Is there a calculator other than the SA one that can actually be trusted on all of this stuff? Or a spreadsheet?

It's all jolly complicated, no single reference seems to cover all cases, and lots of references (including HMRC ones!) just seem to be plain wrong.