More than a million pensioners set to be hit by tax on savings accounts

Pensioners make up nearly half of the taxpayers due to receive an income tax bill from HMRC on their cash savings this year, according to new data.

The tax office expects 1.16 million people over state pension age to have to pay income tax on savings in 2025/26, a Freedom of Information request from investment platform AJ Bell has found.

It means pensioners account for almost half of the 2.64 million taxpayers due to pay income tax on cash savings interest earned in the current financial year.

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We look at the best saving accounts and the best inflation beating accounts in separate articles.

Lower income pensioner households are particularly susceptible to paying tax on their savings, according to the data.

Among basic rate taxpayers, pensioners make up almost two-thirds of those facing a savings income tax bill.

Taxpayers who already file a self-assessment return will need to include the tax liability when completing their filing. But those in the PAYE system may not recognise the tax is due until a tax code change affects their take-home pay or pension income.

Charlene Young, senior pensions and savings expert at AJ Bell, said many people don’t realise how tax applies on the income earned from savings accounts.

“Income tax applies to earnings and pension income first, before savings income and dividends at your marginal rate. This means the government could come calling for 20p, 40p or even 45p from every pound of interest your bank pays out, depending on your other income.”

Personal savings allowance

More people are being dragged into paying tax on their cash savings interest due to a combination of rising interest rates and frozen tax thresholds.

This includes the personal savings allowance for interest, which has been frozen since it was introduced almost a decade ago.

Most people have a personal savings allowance – £500 or £1,000 for higher and basic rate taxpayers respectively.

To work out your tax band, add all the interest you’ve received to your other income.

So for example if you’ve earned £52,000 in income, that makes you a higher rate taxpayer, giving you a Personal Savings Allowance of £500. If you then earn £1,000 interest on your savings, £500 of that will be taxed at your marginal income tax rate of 40%. So you will pay £200 tax on your savings.

Likewise, ISAs and pensions are the perfect way to shield your savings and investments and maximise your returns. Though rumours are swirling the chancellor plans to halve the ISA cash allowance to just £10,000.

“However, millions of taxpayers are still being caught out and that’s particularly true for pensioners who account for nearly half the total,” said Young.

In retirement it is common to hold a little more cash. People often want to de-risk some of their investments and those with a good handle on their spending needs might look to build a cash flow ladder, or funnel, to match what they’ve got planned for the next few years, Young pointed out.

“With an immediate need to take income from assets it is natural to focus a little more on capital preservation, meaning cash becomes an increasingly useful tool, despite the risks from inflation over the long term,” she said.

“Unfortunately, that appears to be leading to a large number of pensioners suffering a tax bill on their cash savings, with increasing numbers being dragged into higher tax bands too.”

How to avoid a savings tax bill

1. Don’t take money out of your pension unless you need it.

Income tax will be due on withdrawals above your tax-free cash allowance. Plus, when the money is outside a pension, if you invest somewhere else it you may be subject to capital gains or dividend tax.

Alternatively, if you park the money in cash you may find yourself with an added income tax bill – joining more than 1 million pensioners with a tax liability on cash savings.

2. Keep cash in your pension instead

If you want to hold cash as part of your investment strategy, you can do so within a pension. You don’t have to hold the money in the bank.

“Your provider may offer a relatively attractive rate of interest on cash held in a pension, or you could hold investment products that are comparable to cash, such as money market funds,” said Young.

3. Use ISAs

Currently you can tuck away up to £20,000 a year into an ISA in cash (though as mentioned this is potentially under threat in the Budget where the allowance could be halved or worse).

Some savers have been paying into regular savings accounts chasing a fractionally higher return in recent years. “But that may have backfired for those who find the tax bill now outweighs any additional interest earned and regret not paying into an ISA sooner,” Young said.

4. Split your cash savings with your spouse

Splitting cash savings accounts efficiently between a married couple is another tax saving trick. You could give your spouse cash savings to use up their tax-free personal savings allowance.

“That’s especially helpful if you’re a higher or additional rate taxpayer and your partner is a basic rate taxpayer, meaning they benefit from the full £1,000 allowance,” said Young.

If one of you has income below the personal allowance (£12,570 for 2025/26), you could also benefit from the starting rate for savings.

This extra allowance is worth up to an additional £5,000 for those on lower incomes and could let you earn up to £18,570 in income and savings interest without paying any income tax.

“The starting rate starts as a £5,000 tax-free band but once your non-savings income – for example income from your pensions, including the state pension – hits £12,570, you’ll lose £1 of the starting rate for every £1 above this,” Young added.