Millions to pay tax on savings interest: how to pay less

While soaring inflation has seen people across the UK lose their spending power, it has been good for savings.

To cool the rate of price rises down, the Bank of England has hiked interest rates to their highest level in 16 years. It means banks have been paying out the best savings rates in more than a decade.

If you’ve been taking advantage of these top-rated accounts, then you could be subject to a tax bill this year. It is estimated that millions of savers will be hit by tax on their savings, including basic rate taxpayers.

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Savers and investors may also face paying higher taxes when selling assets and taking advantage of other income streams due to lower capital gains allowances. The capital gains tax (CGT) allowance for the 2023/24 tax year was £6,000, but has dropped further to £3,000 for the 2024/25 financial year.

Income and capital gains tax is paid by 33.3 million people in the UK and the 100 highest earners pay £46 million each, which is 2% of the tab, according to research by Wealth Club. A freedom of information request by Wealth Club also found that the top 100,000 earners pick up a quarter of the total income tax and CGT bill.

But falling and frozen allowances mean many people will start paying more tax this year. At the same time, not all savers are clear about when their tax liabilities for their savings interest begin, nor how to reduce the chances of having to pay it at all.

So, we've looked at who will pay tax on their savings interest and how to reduce what you have to give to the taxman.

Why are more savers paying tax?

More savers than ever before face paying tax on the savings interest they earn because of the increases to interest rates over the 18-months.

Most of us benefit from having a Personal Savings Allowance. This dictates how much interest we can earn on our savings each year before we have to pay tax on that return. It currently 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 an allowance.

Up until late-2021, the interest rates on savings accounts were modest. So, only those with substantial savings pots earned enough through savings to pay any tax on their savings interest.

However, the base rate has risen substantially as a result of the inflation crisis. In January 2022 it stood at just 0.25%, yet it has been increased repeatedly to its current level of 5.25%, the highest since the financial crisis 16 years ago.

As the base rate has increased, so too have the interest rates on savings accounts. That, in turn, has 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 more in savings interest than your Personal Savings Allowance allows, you will be taxed. The rate of tax you have to pay on anything you get over your allowance depends on your income tax band.

So, 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 probably 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 has jumped significantly. A freedom of information request from investment platform AJ Bell found that HMRC expected more than 2.73 million people to have to pay tax on their savings interest in the 2023/24 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. 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 on savings accounts are now much higher than they were in the 2010s, the amount you can have in a savings account before you start paying tax on it has dropped substantially.

The breakdown below from Charles Stanley highlights how much a basic rate taxpayer will need to have in their savings account, at various interest rates, before having to hand over some of the returns to HMRC. 

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. The deadline is at the end of January. It’s essential to submit your self-assessment before the deadline, to avoid paying fines for late submission. Plus, it’s worth checking the common self-assessment scams that are in circulation, so you don’t get caught out by fraudsters.

How to reduce 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. This allowance refreshed when the new tax year started on 6 April, and it may be worth getting in there as early as possible.

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, which can now be spread across as many accounts as you need.

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. We've explained how much a cash ISA would save you in tax.

But you will have to act fast to bag the top cash ISA rates, as they have been falling since the Bank of England paused the base rate at 5.25% for the fifth time. 

Currently, no ISA matches the base rate, but you can still bag above 5%. Get 5.17% with Plum's Cash ISA (which lets you withdraw three times a year), or you can get 5.05% with Paragon Bank's one-year fixed ISA.

An 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.

However, NS&I has has dropped the prize fund rate on its Premium Bonds from 4.65% to 4.4%, which means fewer prizes will be up for grabs. So, it’s also worth checking Premium Bond alternatives.

Or you could opt to pay more into your pension. While there is the downside of not being able to access it until later in your life, there is the perk of tax relief on your contributions meaning the money you pay in is boosted by the government.