How can I protect a £20,000 windfall from tax after using my ISA allowance?
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I currently use all my normal “tax free allowances” including a cash ISA and the £1,000 personal allowance on savings interest. I came into a £40,000 windfall recently, and put half of this into a bond that matures in April next year (paying 5%), with the intention of shifting this into my 2027/28 Cash ISA.
My question is whether there are any other interest-paying vehicles for the remaining £20,000 that could be exempt from income tax? I have never had to submit a tax return (always PAYE) and do not wish to start now I am retired. A friend suggested that some government loan type products might be suitable.
Max
For most people, in a normal year, a £20,000 annual ISA allowance gives them plenty of room to protect their savings from tax as they go along. When you get a windfall like this, however, it can feel frustratingly small. You mention you’re retired. If you’re aged 65 or over, next year’s Cash ISA allowance will remain at £20,000. If you were younger, you’d see it shrink to £12,000, giving you even more of a headache.
You’ve already taken advantage of the first ports of call for tax-free savings: your Cash ISA allowance and using your personal allowance for savings. The savings bond you mention having taken out will be taxable, so if the interest busts your personal savings allowance, you will have to pay tax on it.
The good news is that given you say you have no other reason for completing a tax return, as long as you make less than £10,000 a year in savings interest and pay tax via PAYE on your pension, HMRC will usually be able to adjust your tax code to collect tax on savings interest, so there may be no need for any extra paperwork.
What are some other options?
For your savings from this point, you have a few options. If you’re in a relationship and manage money as a couple, you could consider transferring assets to your partner, so they can take advantage of their allowances. If you’re married there are no tax implications for this, and if you’re not married the only tax you would need to consider would be inheritance tax (IHT) if you passed away within seven years and held enough assets to pay IHT.
Depending on your age, you could also consider paying some of it into a pension and holding it in cash-like assets like money market funds or cash. If you are drawing an income from the pension, you are likely to have triggered what’s known as the money purchase annual allowance, which will limit your annual contributions to £10,000, but you could contribute this sum, and it would grow free of tax. Given you’re retired, you are likely to be over 55, and therefore able to draw money from the pension when you need it. The income would be taxable, but as long as you are under the age of 75 you will have had tax relief on your contributions, so unless you have changed tax brackets you should be no worse off.
Some people will hold Premium Bonds if they’re in this position. You’re not guaranteed to make a return at all, but any prizes you win are free of income tax. If you hold £20,000 for a year and have average luck, you’ll beat inflation. However, you won’t make any more money than if you had your cash in the most competitive savings account and paid basic rate tax. More to the point, there’s absolutely no guarantee you’ll be averagely lucky, so you could end up winning nothing and being worse off after inflation.
What about gilts?
Other than that, the government loans your friend is likely to be talking about are gilts. They’re loans to the UK government. You lend them money for a specific number of years, in return for a regular payment known as a coupon. When they mature, the government repays the face value (known as par value and usually £100) to whoever holds the bond.
Most people know them as an investment class, which they usually access through a bond fund. However, others use them as an alternative to savings, buying individual bonds through investment platforms. You can buy a bond that’s within a few years of maturity, hold it until the end date, and you’ll get the par value at that point. You need to be comfortable with the fact that if the UK government defaults on its debts, you may not get the full repayment, but that’s highly unlikely.
The key is that gilts with low interest rates (low coupon is the jargon), issued during the pandemic and set to mature soon, tend to be priced below their initial value (par value). At the time of writing, 8th September, for example, there’s one due to mature in January 2028 with a coupon of just 0.125%, priced at £94.66. On its maturity date you’ll get £100 for every £94.66 you put in – so if you bought £19,878.60 worth, you’d get £21,000 back – a gain of £1,121.40.
You’ll also receive the monthly payment until January 2026: £36.75. This will be added to the price you pay and you’ll pay income tax on this. The lion’s share of the return, however, is the difference between what you pay for it and what you get back when it matures.
There are two taxes to consider when it comes to gilts. The coupon is taxed as income, so faces the same issue as savings. However, with low coupon gilts, this is only a tiny fraction of the return. The rest is the rise in the value of the gilt between when you buy and when you are repaid, and this is free of capital gains tax. It means most of your gain is tax-free.
Sarah Coles: Head of Personal Finance
Sarah Coles is AJ Bell’s Head of Personal Finance. She’s passionate about helping people get to grips with their money, so they have more freedom to do the things that really matter to them in...