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Savers - beware the tax man

The good news about rising interest rates is that savings rates are also going up. The top-paying deposit accounts offer up to 7 per cent interest. But before you start working out how much your savings will earn, do not forget about tax.

If you have a bank or building society deposit account the interest on your savings will automatically be taxed at 20 per cent. So if you earn pounds 100 gross interest, this will be taxed at 20 per cent and you will receive pounds 80. Basic rate taxpayers do not pay any more tax, but higher rate taxpayers must declare this interest on their tax return and will have to pay another pounds 20 more tax on it.

If you or your children are non-taxpayers, you do not have to pay tax on the interest from your savings. To receive your interest gross, however, you will need to fill in tax exemption form R85. This is available from the bank or building society where you hold your account, and you will need to fill in a separate form for each account you hold.

The same rules apply to virtually all bonds available from banks and building societies. Typically, interest is automatically taxed at 20 per cent and non-tax payers will need to fill in form R85 if they want to receive their interest gross and free of all tax.

The Inland Revenue has produced A Guide For People With Savings, leaflet IR110, which includes details of how non-taxpayers can receive interest gross as well as how they can reclaim tax already paid. Copies are available from your tax office.

Not all savings schemes are subject to tax, however. Tessas are five- year savings accounts available from banks and building societies. Providing you stick to the rules, you will not have to pay any tax on the interest your savings earn over the five-year term. You can save up to pounds 9,000 in a Tessa.

Company share option schemes (also known as Saye schemes) enable employees to save between pounds 10 and pounds 62.50p a week for five years and at the end of this time invest the money in their company's shares at a preferential price. If instead they decide not to buy shares with the money, then the interest on these savings is tax free. National Savings also offers a range of tax-free savings schemes.