Millions at risk of 'unnecessary' tax bill – how to shield your savings

Millions of savers in the UK are at risk of an "unnecessary" tax bill this year, as billions of pounds are held in savings accounts that do not offer enough protection from the taxman.

Basic rate taxpayers (who earn between £12,571 and £50,270) in the UK hold £516 billion in non-ISA savings accounts that have large enough balances to breach the personal savings allowance, new data from Paragon Bank shows.

The personal savings allowance shields some taxpayers from having to pay income tax on savings interest – basic rate taxpayers can earn up to £1,000 a year in savings interest, while the allowance is £500 for higher rate taxpayers.

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However, 5.2 million UK savings accounts owned by basic rate taxpayers are going to earn more than the £1,000 allowance in interest this year, the data shows, leaving them with a 20% tax bill on the savings interest above the threshold.

The problem becomes even worse for higher rate taxpayers.

Higher rate taxpayers (people who earn between £50,271 and £125,140) have their personal savings allowance cut by half, leaving them with just £500 of tax-free savings interest outside an ISA.

Nine million UK non-ISA savings accounts owned by higher rate taxpayers, worth over £632.7 billion, will earn more than £500 in interest this year, Paragon’s research shows, meaning these savers should prepare for an extra tax bill.

Additional rate taxpayers, who pay the highest rate of income tax, don’t get a personal savings allowance at all, meaning any interest they earn outside an ISA is subject to tax.

Brits who earn above the personal savings allowance in interest have increasingly helped bolster the government’s coffers. HMRC expects to generate £6 billion in income tax on savings interest this tax year, up from £2 billion in the 2022/23 tax year.

Additional rate taxpayers are expected to contribute the most this tax year (£4.2 billion), followed by higher rate taxpayers (£1.3 billion), and basic rate taxpayers (£500 million).

Andrew Wright, head of savings at Paragon Bank, said: “With interest rates having recovered from historic lows and the Autumn Budget just around the corner, millions of savers are leaving themselves exposed to unnecessary tax bills.

“Savers should act now to protect their hard-earned money by moving funds into a tax-free wrapper such as a cash ISA.”

Wright also warned savers that time could be running out to move substantial sums of cash into the tax wrapper as rumours suggest cash ISA thresholds could be reduced in the Autumn Budget on 26 November.

Using an ISA to shield your savings

The easiest way for UK savers to shield their savings interest from the taxman is by using an ISA.

You can put up to £20,000 into ISAs each tax year. There are different types of ISA – including cash ISAs and stocks and shares ISAs. The appeal of an ISA is that any interest or investment income earned within the ISA is shielded from the taxman.

For example, let’s assume you are a basic rate taxpayer who has built up an ISA holding of £100,000 by saving the maximum amount in a cash ISA for five years.

If you placed the entire amount into the best cash ISA on the market right now, from Trading 212, you could expect to earn 4.56% interest over the next 12 months.

At the end of the 12 months, assuming the interest rate did not change, this £100,000 would grow by £4,560. Because this money was held in an ISA, you would not be charged any tax on that.

However, if this £100,000 was held and grown in a non-ISA savings account, the £4,560 earned would breach the £1,000 personal savings allowance, meaning £3,560 of your interest earned would be taxable. You would therefore pay the government £712 in tax.

If you've used up your annual allowance, we look at other ways to shield your savings from tax in a separate guide.