HMRC has estimated that savers will pay over £10bn in tax on interest payments this financial year, highlighting the increasing number of savings accounts breaching their PSA.
In total, HMRC estimates it will rake in £10.37bn during the year, up from £9.12bn during the 2023/24 tax year and £3.94bn during 2022/23, the period in which interest rates started to increase.
Below, we explain five simple steps to consider to keep the tax collector away from your savings interest.
1) Be aware of your savings income and Personal Savings Allowance band
The PSA allows individuals to earn a certain amount of interest on their savings without having to pay income tax on it. The current thresholds are:
- Basic-rate taxpayers: Up to £1,000 of interest income is tax-free
- Higher-rate taxpayers: Up to £500 of interest income is tax-free
- Additional-rate taxpayers: There is no PSA, meaning all interest income is subject to income tax
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The amount savers earn from interest payments has risen over the past two years as the rates offered by providers have increased. Based on a rate of 4.91%, a higher-rate taxpayer would breach their PSA of £500 with a balance of approximately £10,250.
2) Save into a cash ISA
The simplest way for savers to shield their returns from HMRC is to take advantage of their ISA allowance of £20,000 each tax year. This is a tax-free savings vehicle, and every penny held in an ISA is protected from tax.
ISAs have grown in popularity over the past 18 months as savers veer towards breaching their PSA. Bank of England data shows that £4.2bn was poured into cash ISAs during May, a record for the month, with £12.3bn placed in ISAs during April.
Savers considering moving their cash into an ISA should look for providers that offer them flexibility. Some providers, for example, allow customers to open fixed and access ISA accounts, as well as letting them withdraw and top up cash from their ISA during the tax year.
3) Utilise your partner’s tax-free allowance
Although you can’t have joint ISAs, every individual has the same entitlement, so your partner could consider utilising their £20,000 ISA allowance too. This is particularly the case if you have a joint savings account currently held in a non-ISA account.
If you don’t want to save the full amount into an ISA and they are a lower-rate taxpayer than you, you could also consider saving any non-ISA amount in their name, as they will benefit from a higher PSA threshold.
4) Consider how you choose to receive interest
Under the PSA, the tax liability falls during the tax year the interest is accessible. It does not roll over with each tax year.
Therefore, savers with a fixed-rate product with a maturity date longer than one year need to factor in how the method of interest payment will impact their PSA threshold.
Savers can typically choose to receive interest payments on a monthly or annual basis, although some providers will only allow customers to receive interest on product maturity, triggering the full interest earned amount to be assigned to their PSA threshold in that year.
They can also typically choose to accumulate the interest back into the fixed-rate account – so they don’t access the cash – or “pay away” the interest to a nominated account, where they would have access to the money.
If you choose to take interest on maturity or roll it into the fixed account annually or monthly, you won’t have access to the interest earned until the end of the fixed period.
For example, a higher-rate taxpayer with a £10,000 balance in a five-year fixed-rate non-ISA account paying 4% would earn £2,209.97 in interest on maturity if they accumulated the interest within the account.
Based on the interest earned being £1,709.97 above the £500 PSA, the individual would be liable to pay 40% of that amount in tax, equating to £683.09.
If the same individual opted to pay away their interest into a nominated account, they would receive £400 interest on their savings each tax year – below their PSA level and owing nothing to the tax collector.
5) Check whether you or your spouse are eligible for the starting rate for savings
The starting rate for savings in the UK is a tax benefit that allows you to earn interest on your savings without paying tax, up to a certain amount.
There’s a maximum limit of £5,000 of savings income that can be tax-free under the starting rate. This benefit applies only if your income from sources other than savings and dividends (your “non-savings income”) falls below a certain threshold – £17,570 in the current tax year.
This is the sum of your personal allowance (£12,570) and the maximum starting rate for savings (£5,000). If your non-savings income is less than £12,570 (the personal allowance), you get the full £5,000 tax-free benefit on your savings interest.
However, if your non-savings income is between £12,570 and £17,570, you lose £1 of the starting rate for every £1 you earn above the personal allowance. For example, if you earn £16,000 in non-savings income, you would have £3,430 worth of starting rate remaining (£5,000 minus the £16,000 minus £12,570 difference).
The starting rate for savings is primarily aimed at low-income households, but it can be utilised by anybody earning below that rate. Therefore, it could suit households where one partner is a higher earner, but the other doesn’t work, works in a low-income job or has a small retirement income.
Derek Sprawling is managing director of savings at Paragon Bank
