The number of people paying tax on their savings interest is set to hit a record 2.1m this tax year as personal savings tax allowances fail to keep pace with higher savings income caused by high interest rates.
HMRC is well aware of the issue and taxpayers need to be careful not to fall foul of the tax authority, especially as banks share interest earned figures directly with HMRC.
2.1m savers are set to face tax bills as interest rates hit an average 5% across the best rate bank savings accounts, double the number affected last year. This figure is up from just 650,000 in the 2021/22 tax year across all tax rates.
The number of affected basic rate taxpayers is estimated to hit 945,000 in the current tax year, HMRC said, up from just 505,000 in 2022/23.
This means that around one in thirty basic rate taxpayers are expected to pay tax on their savings this year, up from less than one in a hundred just three years ago. While the personal savings allowance protects many people from paying tax on their savings interest, it has remained at current levels since it was introduced more than eight years ago in April 2016.
The tax-free allowance currently stands at £1,000 for basic rate taxpayers earning up to £50,270, and then is halved immediately to £500 for higher rate taxpayers.
Additional rate taxpayers earning over £125,140 get no exemption and pay tax on all cash interest they receive outside a tax wrapper such as an ISA, affecting almost one in 10 of the highest earners.
Those completing a self-assessment tax return will declare any savings interest, and pay any subsequent tax due. But, for those taxed under PAYE, HMRC will calculate any tax due based on information sent to them by banks and building societies.
However, there are ways to minimise the potential tax bill.
Fixed rate accounts
One potential tax trap is fixed rate accounts. Longer term accounts, where the money is not accessible without a charge, pay out interest at the end of the chosen term, say three or five years.
This means that five-year fixed rate accounts can look great on the surface but can be a tax drain. You are taxed on the interest on your savings when it is accessible by you. So, if you pick a fixed-rate savings account that pays out all the interest at maturity, for tax purposes all of that interest will be counted in one tax year. This means that the interest from just one account could take you over your personal savings allowance on its own.
To get around this trap you could opt for an account where the interest is paid out monthly or annually, meaning it is spread across different tax years. Or you can opt for a fixed-term ISA savings account, where you won’t pay any tax on the interest.
Joint savings account
There is also a useful consideration for holders of joint savings accounts.
Lots of people might have savings accounts in joint names, but they may not realise that this means the interest is split 50/50 between the two account holders. It could mean you have taxable interest that you hadn’t realised.
For example, a joint savings account that generates £1,000 interest each year would be split so that each partner has £500 interest to count towards their personal savings allowance.
If one half of a couple is a lower earner, and in a lower tax bracket, it could make sense to move the savings into an account in their name, as any interest that’s taxable will be paid at a lower rate. if one half hasn’t exhausted their personal savings allowance you could move savings into their name to maximise their tax-free amounts.
Food for thought.
