Do I Have to Pay Tax on My Savings Interest?

By Vig Gunasegaran

The increase in interest rates has been welcomed by UK savers who have been able to get a reasonable rate on savings for the first time in over 10 years, as shown in the graph below.

Whilst this has helped somewhat in the face of higher rates of inflation, many savers will have to pay tax on the interest received.  Since 2016, interest from bank accounts has been paid gross to savers (rather than net of basic rate tax, as done previously).  Therefore, savers could find themselves facing an unexpected tax bill.

Sourced: Bank of England website (https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp)

What are the tax rules?

Your Personal Savings Allowance (PSA) is a tax-free allowance that lets you earn a certain amount of interest on your savings without paying tax. The allowance you get depends on what rate of income tax you pay:

  • Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year tax free.
  • Higher-rate (40%) taxpayers: can earn £500 in savings interest per year tax free.
  • Additional-rate (45%) taxpayers: pay tax on all savings income.

If you are a non-taxpayer with less than £12,570 income per year, you may also be able to utilise the “starting rate for savings”.  This allows you to receive up to £5,000 in savings interest before paying tax.

How much do I need in savings before my interest is taxed?

This depends on both the interest rate and whether you’re a basic, higher or additional-rate taxpayer. At current rates, you’d need savings roughly between £10,000 and £20,000:

Basic rate taxpayer Higher rate taxpayer Additional rate taxpayer
Amount in savings £20,000 £10,000 £ –
Interest at 5.1% AER* £1,020 £510 £ –

* Based upon 5.1% interest for an easy access savings account with Insignis Cash Platform.  Top rate at time of writing (October 2023).

What if my annual interest exceeds the allowance?

Your bank or building society will pay all savings interest due to you gross (without tax taken off). You need to register for Self-Assessment if your income from savings and investments is over £10,000.

If you are employed or have a pension income and your savings interest is below £10,000 within the tax year, HM Revenue & Customs (HMRC) may change your tax code so that you pay the tax automatically. To decide your tax code, HMRC will estimate how much interest you may get in the current year by looking at how much you received in the previous tax year.

Those who complete a self-assessment tax return should continue to report any interest on their return.

If you’ve had a tax code change in the past and are now earning less interest than your PSA, you need to contact HMRC as they will need to adjust your 2023/24 tax code. You can reclaim tax paid on your savings interest if it was below your allowance, but you must do this within 4 years of the end of the relevant tax year.

What can I do to limit the tax I pay on my savings?

It is important to consider the main tax allowances when saving, which include:

  • ISAs (Individual Savings Accounts) – ISAs are free from income tax and capital gains tax. All UK residents over 16 have an ISA allowance of £20,000 each tax year.  Over 18’s can save into a cash ISA, investment ISA or combination of both.   Junior ISAs permit contributions of up to £9,000 per tax year for children.
  • NS&I Premium Bonds – You can save up to £50,000 per individual and all prizes are tax-free. Average luck would give a return of 4.65% with prizes up to £1 million (from the September 2023 prize draw).
  • Pension Contributions – You receive tax relief on contributions made into a pension (subject to certain limits).  Also, savings within a pension are not liable to tax on interest or investment growth.

Couples may also want to consider who holds savings. If one individual has a higher tax rate than another, it may be beneficial to hold savings jointly, or in the name of an individual paying a lower rate of tax.  However, care must be taken before transferring savings to ensure this is in line with your wishes.  Transferring ownership also gives control of savings to the new owner.

Conclusion

Higher interest rates are certainly positive for savers, but it does mean that proactively managing your savings and tax position has become even more important.

You should discuss your individual circumstances and options with your Beechwood adviser, who can help find the best solution for you and your family.

It is important to note that tax laws and regulations may change over time.  This information is based upon our understanding of HMRC rules and practice as of October 2023. This post is for information only and should not be construed as advice.