Savers could get a shock tax bill from HMRC as they unknowingly reach the threshold for paying tax on their interest.
The issue affects parents who have a non-ISA savings account for their child, as once a child earns over £100 a year interest on money gifted from their parents, they have to pay tax on the amount.
A poll by investment firm AJ Bell found only a fifth of parents know they could get a tax bill on savings they hold under their child’s name.
Laura Suter, director of personal finance at AJ Bell, warned parents could be “sleepwalking” into picking up a tax bill.
She said: “Parents haven’t had to worry about this tax rule while savings rates have been abysmally low, but now they are creeping up they could find an unwelcome letter from HMRC landing on their doormat with a bill for unpaid tax.
“And you don’t need to have a huge amount in savings to reach that crucial £100 limit. The top children’s easy-access account pays 5.25 percent, which means that once you have £1,900 saved you’ll hit that limit.”
Parents can avoid the tax by switching the funds to a Junior ISA, as any interest on an ISA is tax-free.
Another way to avoid a tax bill is to get friends or family to chip into the child’s savings account instead. The £100 limit applies only to money given by parents.
Ms Suter explained: “Any money paid into the accounts by grandparents, other family or friends doesn’t count towards the limit.
“HMRC say that parents should keep hold of any evidence that payments have been made by other people, so they can prove it later should they need to.”
The poll also found many parents don’t understand how these ISAs work, with one in 10 of those surveyed thinking interest is taxed over a certain limit.
Ms Suter said: “This lack of understanding once again highlights the need for ISA simplification, as the large number of accounts and complexity involved clearly presents a barrier for savers to fully understand the accounts.
“The Chancellor could use the upcoming Budget to simplify the ISA system and build upon the very modest reforms he announced in last year’s Autumn Statement.”
AJ Bell is calling for the tax-free savings limit to be increased to £500 a year given the current high interest rates.
Other savers may also want to reconsider where they have their money held. Research from True Potential found the average saver, with £17,365 in their account, could boost this amount by almost £1,000 in just two years by investing the funds in the stock market.
The Bank of England decided to hold the base interest rate at 5.25 percent again in its recent decision, with many savings providers still offering rates above five percent.
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