Martin Lewis warns of ‘annoying £1 cliff edge’ in tax system and how savers can avoid it

Martin Lewis
-Credit: (Image: ITV)

Martin Lewis and his panel of experts tackled a tax cliff edge on the Not the Martin Lewis Podcast as one caller detailed their income tax question as they found themselves “around the borders” of going into the higher rate band. Along with tax gurus Kari Mellon and Rebecca Benneyworth, the Money Saving Expert shared his frustrations at the income tax brackets represent and detailed how employees can sidestep the higher rates.

The caller, Helen, noted that not only would the higher rate band see her paying 40% income tax but it would also take down her personal savings allowance, giving her just £500 of savings interest tax-free each year instead of £1,000. Rebecca confirmed that Helen was right adding: “There’s quite a few of these cliff edges in the tax system… If you earn an extra pound of income, all of a sudden you’ve lost £500 of exemption.”

The tax guru advised Helen take some money out of her savings to avoid paying the tax on her interest or “moving some to a lower interest rate account” while Martin noted that she could also pay more of her income into her pension to avoid being grouped into the higher rate of tax to begin with. Currently the upper threshold for earnings, both from employment and savings interest, for the basic rate of income tax is £50,270.

He explained: “Let me give you a scenario on this, if your income from work is £49,350 and your interest from savings is £900 then your total income is £50,250 which is £20 below the 40% rate. That means, all of your savings are within your personal savings allowance and all of them are tax-free.

“Now let’s imagine you earn £30 more interest, so you still earn from work £49,350 but your interest from savings is £930. Your total income is now £50,280. You are now a higher-rate taxpayer under the law. So your personal savings allowance is now just £500. On your £930 of interest, £500 is tax-free, £420 is taxed at 20% and £10 is taxed at 40%.”

Comparing the two scenarios, Martin emphasised: “You only get £842 take-home interest on £930. You got £900 take-home interest on £900. So you would’ve been better to earn less interest.” He highlighted that Helen could also put the extra cash into a cash ISA, which is inherently tax-free and slammed the “annoying cliff edge”.