Millions face unexpected savings tax – are you one of them?

Higher interest rates have been a welcome boost for savers, but they’ve brought an unwelcome side effect: a surge in unexpected tax bills.

New figures reveal that 2.64 million people will have to pay tax on their savings interest this financial year, many for the first time. Although the effects of the recent Bank of England rate cut are still filtering though, savings rates remain significantly higher than they were just a few years ago. This, combined with frozen tax allowances, means £6 billion will be paid in savings interest.

Are you one of the millions at risk of seeing your hard-earned interest disappear? We explain why this is happening and the simple steps you can take to protect your money.

What’s on this page?

• The tax catching savers out
• How the tax on savings gets paid
• Why older savers are particularly at risk
• How to protect your savings from the taxman

The tax catching savers out

New data obtained by investment platform AJ Bell reveals the scale of the issue. An estimated 2.64 million people are expected to pay tax on their savings interest in the 2025/26 tax year, according to HM Revenue and Customs (HMRC) projections.

One in 25 basic-rate taxpayers will pay tax on their savings, up from less than one in 100 four years ago. For higher-rate taxpayers, the number has jumped from one in 25 to one in eight. In total, savers are set to hand over £6 billion in tax on interest earned from non-ISA cash accounts.

The core of the issue lies with the personal savings allowance, or PSA. This allowance has been frozen since it was introduced more than nine years ago. It allows basic-rate taxpayers to earn £1,000 in interest tax-free each year. For higher-rate taxpayers, this allowance is halved to just £500, and for additional-rate taxpayers, it disappears entirely.

When interest rates were near zero, these thresholds seemed generous. Before the rate-hiking cycle began in December 2021, a basic-rate taxpayer could have held £154,000 in the best easy-access account without paying a penny of tax. Today, the picture is dramatically different. With the top easy-access account paying around 5%, that same taxpayer will breach their £1,000 allowance with just £19,600 in savings. For a higher-rate taxpayer, £9,800 in savings would be enough to breach the limit.

Interest rates in the current tax year have been lower than last year, but still more people are paying tax on their savings.

That’s partly because the frozen income tax thresholds, whilst pensions and wages have been increasing, mean more people have moved into a higher tax band. That means their personal savings allowance is reduced.

Laura Suter, director of personal finance at AJ Bell, says: “The government has frozen tax thresholds and left the personal savings allowance untouched since it was introduced more than nine years ago. With interest rates rising sharply, more savers are being dragged into the tax net without any policy change. What was once a tax affecting wealthier savers is now catching out everyday basic rate taxpayers.”

Jason Hollands, managing director of Evelyn Partners, says: “Even though interest rates have been on a downward trend since last summer, they remain high compared to the period since the 2008 global financial crisis which ushered in an era of ultra-low interest rates. This means that the amount of tax people face paying on their savings is rocketing and as older people tend to have larger cash savings, they are going to find tax owing that they have not been used to for many years.

“This situation has been exacerbated by the long freeze in the personal savings allowance (PSA), the amount of interest that can be received tax-free each year, as it has been frozen since inception. Under the PSA, basic rate taxpayers can receive £1,000 interest tax-free, which drops to £500 for higher rate taxpayers. Additional rate taxpayers get no PSA at all.

“The number of people being exposed to higher rate tax is also soaring because of frozen income tax thresholds while wages rise, so many people who are still working will potentially see the PSA halve as a result of their earnings crossing into higher rate tax, potentially by just few pounds.”

How the tax on savings gets paid

Many people won’t know they owe tax on their savings until they receive a notification from HMRC. For those who file a self-assessment tax return, the interest must be declared there. However, for most people, including many pensioners, HMRC will collect the tax automatically by adjusting their tax code.

Laura Suter explains: “That can lead to a nasty surprise when people see their take-home pay suddenly fall. Notification that your tax code has been changed will often arrive in the form of an HMRC envelope landing on your doorstep.” If your tax code changes, HMRC can adjust the amount of tax that is deducted from your payslip, or from the pension payments that your pension provider gives you.

If your only income is the state pension and savings interest, HMRC will write to you and tell you how to pay the tax owed.

The system is not perfect. HMRC’s process of matching interest data from banks with taxpayer records is complex, and it admits it cannot reconcile the data in around a fifth of cases.

This means while some may slip through the net, others could be overcharged. So it’s always a good idea to double-check the taxman’s calculations. It can also take time for the records to be matched up, so don’t be surprised to get a bill up to a year after the end of the financial year.

Why older savers are particularly at risk

This issue is a particular concern for those in or approaching retirement. Many will have diligently built up cash reserves to see them through their later years, preferring the safety of cash to the risks of the stock market.

Laura Suter notes: “Older savers who are nearing retirement are particularly at risk of an unwanted tax bill for their cash savings. Many will have built up large cash reserves to spend in retirement... If these cash piles are outside an ISA wrapper, they could face chunky tax bills for the money.”

Furthermore, frozen income tax bands and the rising state pension mean more pensioners are being pushed into the basic-rate tax bracket. This instantly makes any savings interest over £1,000 taxable at 20%.

How to protect your savings from the taxman

The good news is there are ways to shield your interest from tax. The first step is to understand whether you’re at risk of paying tax on your savings or not. Jason Hollands says: “It is important to understand what level of PSA you will receive, depending on your earnings and income tax band. Secondly, you should assess whether the level of interest you are receiving on your cash savings risks exceeding that allowance by the end of the current tax year on 5 April 2026.”

If you think you will exceed your limit, here are four steps to consider:

1. Use your ISA allowance

An Individual Savings Account (ISA) is the simplest way to save tax-free. You can put up to £20,000 each tax year into a combination of ISA accounts, and all interest earned in a cash ISA is completely free of tax. Someone with £100,000 in savings today would need until 2030 to shelter it all within an ISA, so it pays to start as soon as possible.

2. Use your partner’s allowance

If you are married or in a civil partnership, you can freely transfer savings to your partner. Hollands says: “Moving cash to the partner with the lowest income tax band is a smart way to easily save on tax, if you have one basic-rate taxpayer and one higher-rate payer, for example.”

This allows you to make full use of both personal savings allowances. He adds: “It is important to point out though, that when you transfer cash or investments to your spouse, they become the fully entitled legal owner, so trust is vital!”

3. Consider Premium Bonds

Offered by National Savings & Investments (NS&I), Premium Bonds don’t pay interest. Instead, they enter you into a monthly prize draw where you can win between £25 and £1 million. Prizes are tax-free, but bear in mind that most people don’t win anything.  

• Read about whether Premium Bonds are worth it after the latest rate cut.

4. Look into government bonds (gilts)

For those with larger sums who don’t need immediate access, gilts can be a very tax-efficient option. These are bonds issued by the UK government. Jason Hollands explains that because many gilts were issued when interest rates were low, they can be bought for less than their final maturity value.

He adds: “The key point here is that price gains made on gilts are exempt from capital gains tax, so most of the highly predictable return on these will be tax-free.” Gilts are considered a low-risk form of investment, but there is still a risk of losing money, especially if you need to sell them before they mature.

With the savings landscape having changed so dramatically, a quick review of your finances today could save you a significant amount of money tomorrow.