Taxman charges tax on interest that pensioners won't receive for months

New rules on savings mean that pensioners are being taxed on savings interest - before it even hits their bank accounts. In some cases, people are paying their tax bills months in advance, and there's nothing they can do about it.

The revelation was made by the Daily Mail, which started receiving letters from its readers in April, when the new rules on taxing savings were introduced.

The rules provide an allowance that means basic rate taxpayers can receive £1,000 in interest before having to pay any tax. This works fine for anyone who receives less than £1,000 in interest, because there's no tax to pay. The issue hits people who earn more than £1,000 in interest - a category into which many pensioners fall when they use interest as a part of their retirement income. For them, the way the tax is being taken has changed.

Previously, the tax was handled by banks and building societies, which just subtracted 20% in tax before the interest was deposited - so the tax and the interest were naturally paid at the same time.

Now, tax codes are being changed, so the equivalent of the tax that's due is being taken out of their pension every month - spreading their tax payment evenly throughout the year.

The trouble is that their interest payments aren't spread evenly at all. Many accounts and fixed term savings bonds only pay interest once a year, and in some cases they only pay out where they mature after two or three years - which means the tax is being taken months before the interest lands in their account.

What can be done?

HMRC only has a couple of options when it comes to taking tax from us: it can alter your tax code, or you can fill in a tax return. It opted for the tax code to collect tax on interest, because it saves people the hassle of filling out a tax return in order to pay a few hundred pounds. The fact that tax would be paid before interest was received was considered the lesser of two evils.

When asked what people could do about it, HMRC told the Daily Mail: "Changing an individual's tax code to collect tax due is a well-established means of collection that removes the need for many taxpayers to complete a tax return or contact us. If anyone believes they will pay too much or too little tax, they can get their code changed."

Or in other words, tough luck.

What can you do?

It means that pensioners on restricted incomes need to tackle the issue themselves. One option is to always ensure that you use your annul ISA allowance - so that as much of your savings as possible are outside the tax system.

If you still have a large tax bill to cover, this is one instance in which dipping into rainy day savings makes sense - as long as you commit to paying every penny back as soon as you receive the interest payment.

Alternatively, you may need to look to save an equivalent sum elsewhere in your budget each month - by shopping around for everything from utilities to groceries. If you have already made all the cuts you can, another option is to postpone annual expenses like a holiday or a club membership until after the interest is paid.

The final option is the most painful, but will balance your budget effectively after one year - that's not just postponing an annual expense, but forgoing it entirely for a year. That way, you have the extra money in the bank to pay your interest - and you stay one step ahead of the taxman. The only issue then becomes how you will tell the grandchildren you have cancelled Christmas.