How to avoid the savings interest tax trap
Millions of savers are being urged to look at ways to shelter their cash from the taxman as the tax burden on savings escalates
Increasing numbers of savers could face a surprise tax bill on their hard-earned savings due to frozen allowances and thresholds.
Savers have benefited from relatively high savings rates in recent years, but many may not realise they could be hit by the savings interest tax trap.
HMRC lets basic rate taxpayers earn up to £1,000 of savings interest tax-free each year, dropping to £500 for higher rate taxpayers.
Try 6 free issues of MoneyWeek today
Get unparalleled financial insight, analysis and expert opinion you can profit from.
Sign up for MoneyWeek’s free twice-daily newsletter.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
This is known as the personal savings allowance (PSA) and the threshold hasn’t changed since it was introduced in 2016. Additional rate taxpayers don’t get a personal savings allowance.
Higher savings rates mean savers are now more at risk of getting hit with a tax bill as they can earn more interest than they would’ve in the past on the same amount of money.
A Freedom of Information request to HMRC by Paragon Bank shows the number of individuals incurring tax on their savings has more than doubled in just three years, increasing from 1.27 million in 2022/2023 to 2.79 million in 2025/26.
Basic rate taxpayers in particular are being pulled into tax liability – the number paying tax on their savings increased from 613,000 in 2022/2023 to 1.42 million in 2025/2026, a 132% increase. The government’s data shows that, on average, savers in that tax band will pay £641 income tax on their savings.
The number of higher rate taxpayers paying savings tax has also increased from 387,000 in 2022/2023 to 883,000 in 2025/2026, with the average payment for this tax year due to be £2,030.
Under-65s were expected to pay £3.6 billion in tax on savings interest in 2025/26 – an increase of 186% compared with 2022/23, another Freedom of Information request by Paragon Bank to HMRC found.
This trend is only growing.
The number of taxpayers facing tax on savings income is forecast to rise to 4.51 million in 2026/27 – up 269% since 2022/23, according to a Freedom of Information request from savings app Spring.
The number of basic rate taxpayers affected is forecast to more than quadruple in 2026/27, rising 332% from 475,000 to 2.05 million, the largest increase of any tax band, with savers in this band paying an average of £804 per year.
Almost four times as many higher rate taxpayers will pay tax on their savings income, with the number increasing 275% from 405,000 to 1.52 million, paying an average of £1,684 per year, Spring said.
Among additional rate taxpayers, the figure is expected to more than double, rising from 301,000 to 682,000, with these savers paying an average of £5,821 in tax on savings interest in 2026/27.
But there are ways to avoid the savings tax trap.
Savings allowances explained
Tax on savings income is charged at your highest income tax rate, but various allowances can shelter some of it from tax. People with little other income may be able to use some of their personal allowance of £12,570 per year to earn interest tax-free.
They may also benefit from the starting rate for savings, an allowance that begins at £5,000 and is reduced by £1 for every £1 of other income above your personal allowance.
Once your other income gets above £17,570, you no longer get the starting rate for savings, but this is when the personal savings allowance kicks in.
What is the personal savings allowance?
Basic rate taxpayers have a personal savings allowance where they can earn up to £1,000 of interest tax-free each year.
For higher rate taxpayers, that drops to £500, while additional rate taxpayers get no allowance.
One slightly counter-intuitive point to note about the personal savings allowance is that the interest counts when determining your tax bracket.
Consider a saver who had £49,500 in salary and £500 in savings income last year. She was just below the £50,270 higher rate tax band and paid basic rate tax.
Let’s say, this year, her interest rises to £1,500. This means she has £51,000 in total income, which pushes her into the higher rate tax threshold and reduces her personal savings allowance to £500.
How much tax do you pay on savings interest?
Currently, the level of tax you pay on savings is similar to the existing income tax bands.
Basic rate taxpayers pay 20% on any interest earned above the savings allowances, while higher rate taxpayers will owe 40%.
But this is set to change in April 2027 when the rate of income tax applicable to savings income rises by two percentage points.
It will match the rates applicable to income from property, which are also going up in April 2027.
The basic savings tax rate will be 22%, the higher rate will be 42%, and the additional rate will be 47%.
What size savings pots will be hit with tax?
If you have some savings that are not sitting in a cash ISA, you may be surprised at how quickly you breach your PSA and have to pay tax on the interest.
A higher rate taxpayer has a £500 tax-free personal savings allowance. If you’re earning just 1% interest, you would need a balance of £50,000 to earn interest of £500 a year.
But most savers are earning more than that now, given the Bank of England base rate is at 3.75%. A higher rate taxpayer earning 3% on their cash would only need a balance of £17,000 to earn annual interest of £510 and bust their allowance.
How about a savings account paying 6%? You would only need to put £8,400 into that account to exceed your £500 allowance (as you’d earn £504 over the year). A higher rate taxpayer who stashed £20,000 in a 6% account would enjoy annual interest of £1,200 – but would face a tax bill of £280 (£700 x 40% tax).
The top savings rates on the market right now mean you can still get up to 4.55% on easy-access accounts, and 8% if you make the best use of regular saver accounts.
Six options to shelter from tax
1. Use an ISA
Assuming that you still want to hold cash, rather than put it into investments or a pension, the first option is a cash individual savings account (ISA).
Interest is tax-free and you can currently get 4.71% on a top easy-access ISA, and up to 4.77% if you fix for one year. If you’re opening a new cash ISA – perhaps because the interest rate on your current one is rubbish – look out for ones that allow you to “transfer in” your old ISA, as this won’t count towards your annual allowance.
The current ISA allowance is £20,000 per year, meaning this is the maximum you can pay in across your ISAs (including a stocks and shares ISA) each tax year.
ISA rules are due to change though.
From 6 April 2027, under-65s will only be able to put a maximum of £12,000 into a cash ISA each tax year. This could impact how much cash you can save, although you are still able to put the rest in a stocks and shares ISA.
You could also look out for a flexible ISA, which lets you freely withdraw money and put it back within the same tax year, allowing you to take more control over your savings and cover any unforeseen expenses in life.
2. Buy Premium Bonds
If you’ve maxed out your £20,000 ISA limit and still have excess savings you need to shelter from the taxman, another option is National Savings & Investments’ Premium Bonds. These don’t pay interest, but tax-free monthly prizes ranging from £25 to £1 million are up for grabs. The prize fund rate is set to compete with prevailing interest rates.
The prize fund rate will be 4.35% from September, up from 3.3%. It is skewed by the larger prizes that you are very unlikely to win. The average saver with average luck will get a much lower rate of return. Those with only a small amount are likely to end up with nothing.
However, with the maximum holding of £50,000, someone with average luck could expect to win about £1,900 per year. For a higher rate taxpayer who would otherwise pay 40% tax on savings income, this means you will have avoided a £760 tax bill.
3. Overpay your mortgage
If you have surplus cash now – and especially any savings that are at risk of being taxed – a smart move could be to overpay your mortgage. This will increase the equity you have in your home and could get you a cheaper rate when you come to remortgage.
Overpaying also has the effect of reducing the amount of interest you pay and helping you become mortgage-free faster.
Our mortgage overpayment calculator shows how your monthly repayments may change and help you work out if overpaying is worth it.
Before diverting your savings to overpaying your mortgage, it's wise to have an emergency fund of between three to six months worth of essential expenditure first, to make sure you are prepared for any unfortunate scenarios.
4. Pay off other bills
Do you have any bills or debts that need to be paid off? It makes sense to get rid of those first rather than stashing your money away in savings, only to find the taxman takes a slice of the interest.
As well as credit cards and personal loans, you may have bills to pay like your self-assessment tax return.
Self-employed workers usually make two payments on account each year, by 31 January and 31 July. It’s sensible to withdraw cash from a taxable savings account (in other words, not your cash ISA or Premium Bonds) to pay it.
5. Contribute to a pension
If you’re trying to reduce the amount of money you have in savings – and therefore reduce or eliminate a tax bill – another option is to pay into a pension.
This has the benefit of building up your nest egg for retirement – and most of us aren’t saving enough – plus you get tax relief from the government.
If you have a workplace pension scheme you may find that upping your contributions also attracts a bigger contribution from your employer – this is free money, so it’s definitely worth checking.
Alternatively, you could use a low-cost self-invested personal pension (Sipp). Bear in mind that pensions can’t be accessed until age 55 (rising to 57 in 2028), so this option does involve locking your money away.
Also note the annual allowance, which is the maximum you can pay into all your pension pots in one tax year. It is currently set at £60,000.
6. Consider other investments
There are other ways to save tax-free, but they involve investing your money. For example, stocks and shares ISAs, venture capital trusts (VCTs) and enterprise investment schemes (EISs) are all tax-efficient.
Before investing, think about your time horizon (in other words when you want to access the money), your attitude to risk and whether investing is right for you.
Jackie Hall, a partner at accountancy firm RSM, says taxpayers with significant savings and investments may need to think beyond their annual ISA allowance when considering ways to shelter their money.
She explains: “For these individuals, it may be time to think about using an alternative wrapper to house savings and investments, which may include an (offshore or onshore) investment bond.
“The tax charges are deferred until the bond is encashed, although small withdrawals of less than 5% can usually be made each year without giving rise to any tax implications.”
Another option is a personal investment company (PIC). According to Hall, making investments in a PIC wrapper will result in the company being assessed to corporation tax on the underlying income and gains at a rate of not more than 25%. This is 20% less than the top rate of income tax for individuals, which means there can be significant ongoing savings.
She adds: “However, a PIC may not be suitable for short-term investment plans, as an individual will generally incur an additional layer of taxation when extracting profits from the PIC.”
Join more than 165,000 subscribers and keep yourself informed with the latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Marc Shoffman is an award-winning freelance journalist specialising in business, personal finance and property. His work has appeared in print and online publications ranging from FT Business to The Times, Mail on Sunday and the i newspaper. He also co-presents the In For A Penny financial planning podcast.
- Daniel Hilton Writer