While it might be too late to solve the problem for the current tax year, you can organise your savings and reduce the amount of tax you pay on your savings next year.
A previous Freedom of Information request from AJ Bell found that 2.07 million people would end up paying tax on their cash savings in the 2023/24 tax year, up from about 650,000 just three years ago.
These figures include almost one million basic-rate taxpayers, up from just half a million in 2022/23.
Laura Suter, director of personal finance at AJ Bell, said: “The thorny issue is that lots of people won’t realise they owe tax until a brown letter lands on their doormat.
“While those filling out a self-assessment tax return will declare any savings interest, and subsequent tax due, those taxed under PAYE get any tax liability calculated by HMRC, based on information sent to them by banks and building societies. Often, this will then mean your tax code is adjusted and you repay the tax through your payslip each month – eating into your take-home pay.”
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Use your Personal Savings Allowance and ISA
The Personal Savings Allowance (PSA) is the amount of interest you can earn on your savings without paying tax. The amount you can earn depends on your income tax rate.
- Basic-rate taxpayers can earn £1,000 in interest per year tax-free
- Higher-rate taxpayers can earn £500 in interest per year tax-free
- Additional-rate taxpayers do not get an allowance and must pay tax on all their savings interest
Many people may have racked up a hefty tax bill already this year because they didn’t realise they’d breached their PSA.
While April brings the fresh slate of a new tax year and many can fix the problem for next year, if you have large savings outside an ISA, you’ll need to get started now to use up the current tax year’s allowances.
Suter said: “Since the introduction of the Personal Savings Allowance, lots of savers shunned ISAs. But that decision is hitting savers’ pockets now, as many find they have too much money to move it into an ISA in one year. The annual ISA limit of £20,000 is generous, but if you’ve spent years accumulating savings outside of an ISA, you might find you hit that limit pretty quickly when you want to transfer your money into the tax-efficient account.
“If you have [an] ISA allowance remaining this tax year, consider whether you should move some cash into an ISA. Equally, if you have a partner, you could split the cash savings between you to use up both ISA allowances. If your partner pays income tax at a lower rate, it might make sense to move any savings that will attract tax into their name. Just make sure the savings interest doesn’t tip them into the next tax bracket and undo all your good organising work.
“There are lots of ways people might be caught out by a tax bill on their savings, not realising that they might owe tax on their cash. Here are four ways the tax might sneak up on you and land you with an unexpected bill.”
Keep an eye on fixed rate accounts
Many savers lock in to fixed rate accounts for guaranteed returns, but few realise the tax risk. Interest is taxed when it becomes accessible, so if your account pays at maturity, years’ worth of interest lands in one tax year, potentially pushing you over your PSA.
Longer-term accounts are most at risk. For example, £7,000 in a top three-year fix at 4.63% would generate £1,018 interest at maturity, exceeding a basic-rate taxpayer’s £1,000 PSA.
Suter said: “To avoid this, choose an account that pays interest monthly or annually, or opt for a fixed-term ISA to keep your interest tax-free.”
Think about your kids’ savings
If your child earns more than £100 interest on money you’ve gifted, it’s taxed as yours.
With top children’s accounts paying 5%, just £2,000 in savings could hit this threshold. Once that limit is breached, all the interest (not just the excess above £100) counts as the parent’s income, eating into their PSA and potentially becoming taxable.
To sidestep this, use a Junior ISA or split contributions between each parent to make sure the tax hit is spread. Equally, if one parent has PSA left, they should be the one to contribute.
Make the most of joint accounts
Joint savings accounts split interest equally between holders, which could create unexpected tax bills. For example, a £1,000 interest payout is split into £500 each, which would push a higher-rate taxpayer over their PSA if they have other cash savings interest.
Suter said: “If one partner earns less, it may be tax-efficient to move savings into their name. A higher-rate taxpayer would pay £400 tax on £1,000 interest, while a basic-rate taxpayer would pay just £200. Even if in the same income tax bracket, using a partner’s unused Personal Savings Allowance can reduce a couple’s tax bill.”
