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More people are paying tax on their savings as interest rates have risen and annual allowances remain frozen. But there are ways to protect your cash, by using HMRC rules to cut down the tax you pay on savings.
So, what do you need to do to make the most of your money?
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Most people have a Personal Savings Allowance. This is the amount of interest you can earn on your savings before tax kicks in. The allowance is £1,000 for basic rate taxpayers, and £500 for higher rate taxpayers.
Additional rate taxpayers don’t get an allowance. If you live in Scotland, the same UK thresholds of £50,271 for higher rate tax - or £125,140 for additional rate tax - dictate your savings allowance, even though Scotland has different income tax thresholds.
Any interest you earn on your cash above the Personal Savings Allowance is taxed at the same rate as your income; 20% for basic rate taxpayers; 40% for higher; 45% for additional.
Laura Suter, director of personal finance at AJ Bell, says it used to be the case that most people didn’t need to worry about paying tax on their savings, as interest rates were low and the Personal Savings Allowance was sufficient.
“But now a tricky combination of interest rates rising, cash ISAs being shunned for decades, more people moving into higher tax brackets and seeing their Personal Savings Allowance cut, and the tax-free allowance being frozen means lots of people are being dragged into the tax,” she adds.
New figures obtained by Shawbrook Bank suggest that 6 million accounts are in line to pay tax on interest in the current tax year – a rise of 800,000 in a year. The calculations have come from monitoring platform CACI, which looked at data from contributing members of the monthly Current Account and Savings Database in October 2024.
The figures are based on accounts earning more than 1,000 in interest.
Cash ISAs fell out of favour when interest rates were at rock bottom for several years. But with the Bank of England Base Rate now at 4.75% – making it possible to earn a decent amount of interest – cash ISAs are a more attractive option.
The reason is simple. If you had £20,000 in a savings account paying 5% interest, in a year you’d earn £1,000. If you're a higher earner, you’d have to pay tax on £500 of that. But if that £20,000 was in a cash ISA you wouldn’t have to pay any tax on those gains.
You can put up to £20,000 into ISAs every tax year. Before April 2024, you couldn’t open two ISAs of the same type in the same tax year. Now you can – as long as you don’t pay in more than the total ISA limit of £20,000 a year. If you are married or in a civil partnership, you could consider your partner’s allowance to take your overall household ISA allowance to £40,000.
Read more about how to cut your tax bill with an ISA. You could also consider a stocks and shares ISA if you want to go beyond cash savings. Lucie Spencer, financial planning director at wealth management firm Evelyn Partners, adds: ”The obvious shelter is a cash ISA but some might use up their £20,000, or prefer to use the allowance for investing.
So it is good to have strategies to minimise the amount paid in tax on non-ISA cash savings.”
You are taxed on interest on your savings based on when it is paid to you. Many fixed-rate savings accounts pay out all the interest at maturity, even for three or five-year fixes. That interest will be counted in the tax year when the account matures.
This could potentially take you over the personal allowance for savings interest in that year. If you want to spread the interest across tax years, you could opt for an account where the interest is paid out monthly (or even annually, if it’s a multi-year fix). We give tips here on how to boost your savings returns.
Premium Bond prizes are tax-free, although there’s no guarantee of winning. Some savers dislike that they might win less than the average prize rate, and missing out on potentially a higher rate of interest in other types of savings accounts.
Others love the fact they have a chance of winning a big prize while possibly also receiving a decent return via small monthly prizes. “The annual prize fund rate for Premium Bonds is currently 4%, which might at first glance look unattractive compared to a 5% fixed savings rate,” Spencer says. “But it is the net savings return that matters.
“The Premium Bond 4% is tax-free. The 5% savings rate is gross, and if it is subject to income tax, will for a basic rate taxpayer reduce to 4% net, while for higher-rate it would be 3% net, and even less for additional rate.”
If you’re in a trusting relationship, make use of joint savings accounts. Interest on joint accounts is split 50:50 between the two account holders.
For example, a joint savings account that generates £1,000 interest each year would be split so each partner has £500 interest to count towards their Personal Savings Allowance.
Another option could be moving cash savings into an account in your partner’s name, again only if you’re in a trusting relationship. Suter says: “If they pay tax at a lower rate than you, or haven’t used up their Personal Savings Allowance yet, this could help eliminate your savings tax bill.”
If you’re still working, and are in a higher tax band, to avoid losing some or all of your Personal Savings Allowance you could pay some of your earnings into your pension (and/or give some of it to charity) to move you back down into a lower tax bracket.
For example, if your total income is £70,000 a year and you paid £20,000 into a pension, this would take your “adjusted net income” to £50,000 and keep your Personal Savings Allowance at £1,000 rather than £500.
Making gift aid donations to charity can also help to reduce your "adjusted net income" for tax purposes, which could help to move you into a lower tax bracket.
Don’t forget to factor in any additional sources of income, such as savings interest and dividend payments, when calculating your total income.
If you have a relatively low income, you could have a much bigger savings allowance.
The £5,000 Starting Rate for savings can apply as long as your total income is not more than £17,570. As your total income rises above the £12,570 Personal Tax-free Allowance, the starting rate is reduced pound for pound until at £17,570 you are no longer eligible.
Spencer says: “This means someone whose only income is the State Pension, for instance, which is currently less than the personal income tax allowance, could pay no tax on up to £5,000 of savings interest.”
Dividend income is taxed after savings income, so if you have dividend income it will not affect whether you are eligible for the Starting Rate for savings on your savings income.
In the case of couples there’s an opportunity to use the Starting Rate by switching cash savings to the eligible partner, Spencer adds.
Once a child earns £100 or more in interest on money that has been gifted by a parent, it is taxed as though it’s the parent who has earned the interest. If you’re near (or already over) your Personal Savings Allowance, you could be hit with unexpected tax. Note that this doesn’t apply to money given by grandparents or other relatives.
If you’re saving money for your child, a Junior ISA account means that all interest will be protected from tax. It can also be worth considering which parent makes the gift, if one of them is more likely to go over the savings allowance than the other. Or you can make sure both parents make equal payments to children, to use up both savings allowances.
Finally, when it comes to paying tax on your savings, it’s not just cash you have to worry about. Suter warns: “With an investment fund, if the fund invests more than 60% in bonds and cash, then payments from the fund are classed as interest, rather than as dividends.”
Your investment platform or provider will usually send you a tax statement each year to show you how much you’ve made in interest in that tax year, to help with your calculations.
This shouldn’t be an issue if you hold investments in ISAs and pensions or invest in funds that hold mostly equities. But it’s worth watching out for just in case.
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