If you have savings of £3,501 or more, you might want to pay close attention to how HMRC taxes your interest earnings. With interest rates on the rise, more UK savers are unknowingly exceeding tax-free limits—leading to unexpected tax bills.
How Much Interest Can You Earn Tax-Free?
The Personal Savings Allowance (PSA) determines how much interest you can earn before paying tax. It depends on your income tax band:
- Basic-rate taxpayers (20%) – Up to £1,000 in interest tax-free
- Higher-rate taxpayers (40%) – Up to £500 in interest tax-free
- Additional-rate taxpayers (45%) – No tax-free allowance
If your interest earnings exceed these limits, you’ll need to pay tax on the extra amount.
Why More People Are Paying Tax on Their Savings
Thanks to higher interest rates, many savers are now earning more interest than they used to. For example, if you have £20,000 in a savings account with a 5% interest rate, you’ll earn £1,000 a year. That’s fine if you’re a basic-rate taxpayer, but higher-rate taxpayers will be taxed on anything over £500.
Even if you only have £3,501 in savings, you could still be affected if rates continue to rise. That’s why it’s essential to know where you stand.
How HMRC Collects Tax on Savings
You won’t receive a tax bill in the post HMRC collects savings tax automatically. Banks and building societies report interest payments to HMRC, and if you owe tax, it’s usually deducted through your tax code. In some cases, you might receive a P800 tax calculation or a Simple Assessment to inform you of what’s owed.
How to Reduce or Avoid Tax on Your Savings
Want to keep more of your hard-earned interest? Here are a few smart ways to reduce or eliminate tax on your savings:
1. Use an ISA
Individual Savings Accounts (ISAs) let you earn tax-free interest, and you can deposit up to £20,000 per year. Unlike regular savings accounts, interest earned in an ISA doesn’t count towards your PSA.
2. Consider Premium Bonds
Instead of earning taxable interest, Premium Bonds give you a chance to win tax-free cash prizes. While returns aren’t guaranteed, it’s a risk-free way to potentially earn more.
3. Check If You Qualify for the £5,000 Savings Starter Rate
If your total income (excluding savings interest) is below £17,570, you might be able to earn up to £5,000 in interest tax-free. This benefit decreases as your income increases, so check if you qualify.
4. Split Savings Between Partners
If you’re married or in a civil partnership, consider shifting savings to the partner with a lower tax rate. This way, you can take full advantage of both Personal Savings Allowances.
Final Thoughts
With interest rates rising, more savers are hitting the tax threshold without realizing it. Checking your PSA, using tax-efficient savings options, and planning ahead can help you avoid unnecessary tax bills.
Before the tax year ends on April 5, 2025, take a moment to review your savings strategy, you might save yourself a costly surprise from HMRC!
