If you’ve been taking advantage of the best savings accounts, where interest rates have gone above 5%, then you could be subject to a tax bill this year depending on how much you save.
It is estimated that millions of people will pay tax on savings this year. As interest rates have risen, the number of savers potentially subject to tax on their returns has increased substantially, presenting a boost to the Treasury’s coffers.
However, not all savers are clear about when they will start paying tax on their savings interest, nor how to reduce the chances of having to pay it at all.
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We look at who will pay tax and if how to reduce what you give to the taxman.
Why are more savers paying tax?
More savers face paying tax on the interest they earn because of the increases to interest rates over the last year or so.
Most of us benefit from the Personal Savings Allowance. This dictates how much interest we can earn each year from our savings before we have to pay tax on that return, and stands at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. If you are an additional rate taxpayer then you don’t get a Personal Savings Allowance.
In recent years, with the interest rates on savings accounts so modest, only those with substantial savings pots earned enough that they needed to pay any tax on their interest returns.
However, base rate has risen substantially of late. In January 2022 it stood at just 0.25% yet has been increased repeatedly to its current level of 5.25%, the highest since the financial crisis.
As base rate has increased, so too have the interest rates on savings accounts, and that has in turn bumped up the interest earned from our savings pots. As a result, increasing numbers of savers face handing over some of the interest payments to the taxman.
How much tax will I pay on my savings?
If you earn above the Personal Savings Allowance from your savings then you will be taxed based on your income tax band. As a result, basic rate taxpayers will pay 20%, higher rate taxpayers will pay 40% and additional rate taxpayers will pay 45%.
There is a further allowance in the form of the ‘starting rate for savings’, reserved for low earners. If you have taxable income below £17,570 then you will benefit from a 0% rate on the first £5,000 of your savings income, rather than £1,000.
The more money you have in savings and the higher your income tax band, the more you will have to pay in tax on your savings interest.
How many people pay tax on their savings interest?
The number of people paying tax on the interest from their savings is set to jump significantly.
A freedom of information request from investment platform AJ Bell found that HMRC is expecting more than 2.73 million people to have to pay tax on their savings interest in the current tax year. That includes 1.37 million basic rate taxpayers.
That’s a rise of around a million overall on the 2022-23 tax year, while back in 2020-21 fewer than 800,000 savers paid tax on their savings interest.
When will I start paying tax on my savings?
As interest rates have grown, the amount needed to have in savings before you start to be liable for tax has dropped substantially.
The breakdown below from Charles Stanley highlights how much you will need to have in your savings account, at various interest rates, before you will end up having to hand over some of the returns to HMRC.
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How do I pay tax on my savings?
How you pay tax on your savings can vary.
If you are a pensioner or employed, then HMRC will change your tax code. As a result you will pay the tax automatically. The taxman essentially estimates how much you’re likely to earn in interest, based on how much you got in the previous year.
However, if you file a self-assessment tax return then you can report the interest you’ve earned there.
How to avoid paying tax on your savings
The simplest way to reduce the amount of tax you pay on your savings is to make use of your ISA allowance.
All savers enjoy an annual ISA allowance, which sets out how much you can save within an ISA wrapper in each tax year. It currently stands at £20,000, though there has been speculation that the Chancellor, Jeremy Hunt, may be looking to hike the ISA allowance in the upcoming Autumn Statement.
Any interest earned through ISAs is free of tax, and so does not count towards your Personal Savings Allowance. Therefore prioritising your ISA is a good way to keep more of the returns from your savings.
Another alternative may be to make use of savings accounts that don’t pay interest. For example, with Premium Bonds you are entered into a monthly draw, with the potential to win a tax-free cash prize. If you are lucky, then you may end up with a much more significant return on your money than through a traditional savings account.
Or you could opt to pay more into your pension. While there is the downside of not being able to access it until your later years, there is the perk of tax relief on your contributions meaning the money you pay in is boosted by the government.
John Fitzsimons has been writing about finance since 2007, and is a former editor of Mortgage Solutions and loveMONEY. Since going freelance in 2016 he has written for publications including The Sunday Times, The Mirror, The Sun, The Daily Mail and Forbes, and is committed to helping readers make more informed decisions about their money.
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