Income Tax on your savings: Will you pay, how much, and what can you do about it?
Will you pay Income Tax on the interest paid to your savings? Find out about the little-known Personal Savings Allowance and what you can do to reduce your bill.
Your cash savings are an essential part of your financial stability, giving you a pot of money that’s easy to access in emergencies or for one-off expenses. And, if you put your savings in an account that pays interest, your money will grow over time.
But in June 2024, it was reported that HMRC was set to take more than £10 million in Income Tax from savings interest in the 2024/25 tax year alone.
The report, published by MoneyWeek using HMRC data, said that this figure was an increase on £9.1 million in 2023/24, £3.9 million in 2022/23, and £1.9 million in 2021/22.
These surprising increases indicate that more savers are breaching the Personal Savings Allowance (PSA), a tax break that protects some savers’ interest from being subject to Income Tax.
This begs the question: could your savings interest be at risk of being eroded by tax, and if so, is there anything you can do?
Continue reading to learn what you need to know about the PSA and how to reduce the impact of tax on your savings.
Your Personal Savings Allowance is determined by your Income Tax band
As of the 2024/25 tax year, and set to continue into 2025/26, the PSA – the amount of interest savings outside of an ISA can generate without Income Tax being due – is as follows:
- Basic-rate taxpayers get £1,000
- Higher-rate taxpayers get £500
- Additional-rate taxpayers do not have a PSA.
If you’re a basic- or higher-rate taxpayer, and you exceed the PSA, HMRC may contact you. Or, you could need to self-assess and declare your interest payments, at which point the amount exceeding your PSA may be added to your overall bill.
As an additional-rate taxpayer, you will need to self-assess annually, even if you are employed. You should declare interest payments and your Income Tax bill will incorporate this addition.
3 simple options to explore if your savings are at risk of being exposed to tax
Income Tax receipts from interest are rising because savings accounts are offering significantly better rates today than they were in 2021/22 and beforehand.
The Bank of England base rate rose from just 0.1% to 5.25% between December 2021 and August 2023, and now stands at 4.25%. Due to this increase, your savings likely went from earning very little interest to accumulating hundreds or thousands a year.
Here are two options you could explore if your savings interest is exposing you to more Income Tax.
- Save into a Cash ISA
As you read above, Income Tax on savings interest only applies to funds kept outside of an ISA.
Imagine that you are an additional-rate taxpayer approaching retirement. You keep a cash fund of £25,000 in an easy access savings account for emergencies and luxuries – sensible so far – and earn 4% interest on it. In a year’s time, your savings will be worth £26,000.
Seeing as you don’t benefit from any PSA at all, this additional £1,000 will very likely be eroded at your marginal rate of Income Tax, meaning you’d benefit from only £650.
That’s where using a Cash ISA is so vital. You won’t pay Income Tax on any interest earned within this type of account.
At the time of writing, Cash ISAs are included in the annual £20,000 adult ISA allowance. So, if you have a Stocks and Shares ISA or Innovative Finance ISA (IFISA), you’ll want to split your annual contributions between the accounts, making sure they don’t exceed £20,000 in total.
Imagine your £25,000 is still sitting in an easy access account.
Towards the end of the 2024/25 tax year, you still have £10,000 left of your annual ISA allowance, having already invested £10,000 in your Stocks and Shares ISA.
You place the remaining amount into a Cash ISA, meaning there’s £15,000 left in your easy access account.
On 6 April, when your allowances reset, you review your ISA strategy for the year and dedicate the remaining £15,000 to your Cash ISA. Now, you could gain the full £1,000 a year – provided that your Cash ISA pays the same amount of interest – without any tax being due.
Within three years, without paying a single additional contribution into your Cash ISA, your £25,000 fund would grow to £29,246, all earned tax-efficiently.
Of course, this is just an example of how Cash ISAs might help you mitigate tax, and there are important risks and pitfalls to consider. Speak to a financial planner before you begin moving large sums between accounts.
- Invest a greater portion of your wealth
If a large amount of your wealth is kept in cash, not only might it be vulnerable to Income Tax on its interest payments, but it may not grow when compared with inflation over time. Whereas, investing your money over the long term could produce better growth and give you a financial advantage later in life.
Schroders research has determined that over time, the chance of your cash beating inflation is far less than the chance of equities doing the same.
Above, you can see that shares have historically outpaced cash when measured against inflation. The longer the time frame, the more likely this is to be the case. As with all investments, the value of your investment can go down as well as up, and you may not get back what you put in.
It’s also important to note that, while investing may help you avoid paying Income Tax on your savings interest, other forms of tax could apply when liquidating shares and other assets.
For instance, Capital Gains Tax (CGT) is usually due on gains made outside of an ISA. If you are selling property investments, different rules apply, but you could still pay CGT.
Read more: Will you pay more Capital Gains Tax as a result of the Autumn Budget?
With this in mind, it’s worth speaking to a qualified financial planner before making decisions that could affect your tax bill. We believe long-term investing is essential for financial freedom, but everyone is different, and the above suggestions might not fit your circumstances.
Get in touch
To work with a professional who may help you mitigate tax and keep more of your hard-earned wealth, email us at hale@kelland.co.uk, or call 0161 929 8838.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.