Tax on interest on long term fixed rate bond

I have read through a couple of threads on this subject (and trawled the internet) but am still unclear on how the taxation on interest would work. I have a 5 year fixed rate bond with a 5% AER - it started in November 2022 and matures in November 2027. I have opted for the interest to be paid Monthly into the same account so the interest can compound - and I can see it being credited. Each month the account is credited with approx £40 interest. My expectation was that for Tax year 2022/23 I would declare 5 months interest (credited 1st Dec to 1st April) and for most of the following years it would be 12 months of credits with a final 7 months of credits (May 1st to Nov 1st 2027). This to me makes perfect sense. I have now been confused by some information posted on the moneysavingexpert forum that says the interest would in fact, all need to be declared at the end of the 5 year term, with nothing being declared until then, since I cannot access the interest until the fund matures in November 2027, if the interest is added to the same account. If it's left until the very end to declare all of the interest, I will have to pay tax on the interest, since it will exceed my PSA, being the total interest will be approx £2,500 but to my mind, I am only receiving £500 per year, which would be under my PSA for each year. I do have the option to have the interest paid out but that would reduce the benefit of compounding. Do I have to get the interest paid out in order to be able to declare the interest each year? Or can the fact that I have the option to have it paid out, mean I can still declare each year, even though I won't have access until 2027?

Hi,

Much will depend on the type of account you have. If you have access to withdraw any of the funds at any time, then the interest will be taxable in the year in which it arises. If you have an account where you cannot access the funds until the end of a set term, then the interest would be taxable at the end of the fixed term, when you can access the funds.

Thank you.

I will have no access to the principal sum for 5 years. The interest I can have paid out to a different account or I can have it paid into the same account, so the interest can compound. I want to have the interest compounded, to benefit most from the 5 year term. But if the interest is only taxable after 5 years I will have to pay tax, whereas if I pay tax on what I receive each month, I would not. This does not seem to make any sense. I can see the interest being received into my 5 year account each month, so I don't understand why it is not taxable at the point of receipt? If we went back to the days when interest was paid net, I would be taxed each month (i.e. I would receive interest less 20% tax) and then claim back the tax at a later date. Why are things different now interest is paid gross, for a long term savings account?

Note that I can close the account (and therefore withdraw the funds) if the t&c's or charges change or under "special circumstances" agreed with the provider but I can't see e.g. a way to withdraw if I pay a penalty

One further query; if the provider sends me an annual "Statement of Interest", showing interest earned for each tax year, should I declare the interest earned in each tax year, or should I defer declaration of each years interest until the end of the fixed term?

Hi,

By having the interest paid into another account this means that you can access it to allow a withdrawal and as such would be taxed on an annual basis. For keeping it in the bond, whilst it may be applied annually, you cannot actually access the funds until the fixed term is finished. If you then choose to close the bond early, this is also seen as being able to access the fund and the interest and you would therefore need to declare the interest in that tax year.

Thank you.

Thanks; It seems that I have no option but to have the interest paid out of the account, so that the interest I receive each month will be taxed each tax year, rather than all in one go at the end of 5 years. This certainly seems like a flaw in the system, that I believe should be changed. As things currently stand, compounding the interest in a 5 year bond means my annual psa would go completely unused for 4 years. That cannot be right.

Hi,
 

This is set out in the guidance : Savings and Investment Manual  .

Thank you.

Thanks for the link to the manual. Makes interesting (no pun intended) reading... 1. “A person may be taxable on interest even if they cannot withdraw and spend the money.” 2. “If an individual is unable to withdraw or have access to the interest when it is credited to their account, or has a specific product such as a bond, the interest will not arise and therefore they will not be taxable until they have access to the interest.” Can I have option 1 please?

After checking the example 2 on SAIM2440, I would like to know whether I need to report the interest earned annually if I can close the account earlier by paying penalty

Hi,

You cannot opt for one choice or the other. If the terms and conditions of the bond did not allow access until maturity, the interest would arise and be taxed at that point. You are therefore bound by the conditions of the account.

Thank you.

Hi Tommy Leung,

The interest would become taxable in the tax year in which you close the account, whether that is at the end of the term or part way through the term.

Thank you.

Sorry to persist with this query but it makes no logical sense that the interest only "arises" at the end of a long term. I receive interest into my bond account each month. It shows in my account dated at the point of receipt. It is my interest at that point. In April the bond provider will send me a "Statement of Interest" showing the interest I have received during the tax year. I am expected to NOT declare the interest I have received each year until the bond matures in 2027 - at which point I declare 5 years worth of interest. Even though I have only received £500 per year (half my annual PSA of £1,000), because the whole 5 years of interest amounts to approx £2,500, I will have to pay tax on £1,500. Is it possible to have someone review the way this works as it makes no sense and is totally unfair. I doubt that anyone taking out a long term bond even realises this and would logically report the interest their provider shows on the annual statement each year

Thanks for your reply. But I still have queries. for example, I made a two-year fixed bond in a bank which pay interest annually, I cannot withdraw from the account but can close it early by paying penalty (is this condition means gain access to both annual interest and the principal). My question is If I don't close the account. Do I need to report the interest earned each year or report the lump sum interest when it matures in two years. Thanks.

Hi Tommy Leung,

Interest ‘arises’ when it is received or made available to the recipient.
Interest has been made available if it is credited to an account on which the account holder is free to draw.
For additional guidance on when interest arises see:
SAIM2400 - Interest: taxation of interest: the tax charge ‘Interest arising’

Thank you.

If interest only arises at the end of the term (over 1 year) shouldn't banks/building societies be advised by HMRC NOT to send a certificate of interest until the interest is accessible? - end of term or when account is closed. Or it it a case that if they do issue an annual certificate of interest, you should report the amount the bank says you have received on your annual return?

@Tommy Leung The example you mention (SAIM2440) clearly states that the interest arises and is taxable each year: "Since the terms and conditions of the bond allow Sam to draw on the funds, although with a penalty, the interest arises and is taxable each year as it is credited" So your situation, based on that example, seems to me, to be that you do declare year 1 and year 2 separately. It does not make any sense to me that it would only arise at the end of the term but the feedback on my query is still unclear to me - though the last response does say "received OR made available". To me I have received the interest when it appears in my account (whether I can access it or not) and certainly if the provider sends me a statement showing my interest for the tax year, I would expect to report that amount to HMRC and not withhold those receipts until the end of the term.

Hi rl11
This has already been answered and no change to advice already given.
The guidance is as set out in previous reply and this is legislation.
Thankyou.

After checking SAIM2400, I am still confused, In my case, I made a two-year fixed bond that I could not withdraw them from the account. I can only close the account early by paying a penalty. If I don't close it, I only need to declare the one-time interest when it is due. Is that correct? Thanks for your help.

Can you please point me to the "legislation" that explains the notion of taxing interest only at the end of the term? I have only been able to find guidance - which also states the following in regards to interest: “it was held to include the ‘swelling of a person’s assets’ even where the person had no immediate right to the income” "A person may be taxable on interest even if they cannot withdraw and spend the money" It makes perfect sense that if the interest on a 5 year bond is only paid at maturity, then the interest is taxed at the point of maturity. In all cases where the interest is credited annually or monthly it also makes perfect sense that the interest is taxed during the tax year in which it is credited - particularly if a "Statement of Interest" is issued by the provider showing the tax year in which the interest was credited. Can you confirm that your advice is that I should ignore my statements that will show I received £200 interest for tax year 2022/23 and £480 for each tax year 2023/24 through to 2026/27 and £280 in 2027/28 and instead declare that I received all of the interest in 2027/28?