Do you have money tucked away in a savings account? You might be wondering if you’ll have to pay tax on the interest your savings earn. The good news is that UK savings tax rules have changed in recent years, and many people pay no tax at all on their savings interest. This is thanks to several HMRC tax allowances designed to help savers, including a key one called the Personal Savings Allowance (PSA). In this blog, we’ll break down what these allowances mean for you and how you can make the most of them to keep your savings interest tax-free.
Understanding UK Savings Tax and HMRC Allowances
Interest you earn on your savings is considered income, which means it’s subject to income tax. However, HM Revenue & Customs (HMRC) provides specific allowances that reduce or eliminate the tax you owe on savings interest. Essentially, these allowances ensure that most people don’t have to pay any UK savings tax on their bank interest. In fact, the majority of UK savers now pay no tax on their savings interest because of these rules.
Let’s explore the different allowances HMRC offers that can apply to your savings:
What Is the Personal Savings Allowance (PSA)?
The Personal Savings Allowance (PSA) is a special tax-free allowance introduced to benefit savers. It allows you to earn a certain amount of interest each tax year without paying any tax on that interest. The exact amount of your PSA depends on your income tax band:
PSA by Tax Band
Basic-rate taxpayers (20% income tax)
You can earn up to £1,000 in interest per tax year tax-free. This means if you’re in the basic 20% tax bracket, the first £1,000 of interest you earn is not taxed at all.
Higher-rate taxpayers (40% income tax)
You can earn up to £500 in interest per year without paying tax on it. Any interest above £500 will be taxed at your 40% rate.
Additional-rate taxpayers (45% income tax)
You do not receive a Personal Savings Allowance. All your savings interest is taxable (so it’s especially important to plan your savings if you fall into this bracket!).
For example, if you’re a basic-rate taxpayer and you earn £800 of interest in a year, you won’t pay any tax on that interest because it’s within your £1,000 allowance. If you earn a bit more – say £1,200 of interest – then only the £200 that exceeds your allowance would be taxed (at 20% in this case). The PSA resets each tax year (which runs from 6 April to 5 April), so you get this benefit every year as long as the rules remain the same.
The Personal Savings Allowance has made savings interest effectively tax-free for most people. However, it’s not the only allowance that can spare your interest from taxes. Let’s look at other HMRC tax allowances and rules that can affect your savings.
Other HMRC Tax Allowances for Savings
Aside from the PSA, there are a couple of other allowances and rules that can help reduce or eliminate tax on your savings interest:
- Personal Allowance: This is the standard amount of income everyone in the UK can earn without paying income tax, typically around £12,570 (though this amount can change with government budgets). If you have little or no earnings from salary or pension, you could use part of this Personal Allowance for your savings interest. In practical terms, if your other income is low, some (or all) of your interest can fall within your tax-free Personal Allowance.
- Starting Rate for Savings: On top of the Personal Allowance, there is a special 0% tax band on savings interest up to £5,000. This benefit is aimed at people with very low incomes. Essentially, every pound you earn above your Personal Allowance chips away at that £5,000 0% band for savings. So, if your other income is high enough (around £17,570 or more in a year), this starting-rate benefit disappears entirely. But if your other income is well below that, you can take advantage of some or all of this £5,000 band and get additional interest income taxed at 0%. In the best-case scenario (with no other income at all), you could earn a full £5,000 of interest tax-free under the starting rate in addition to your Personal Savings Allowance.
These allowances mean that certain individuals – for instance, pensioners or others with only a small salary – can earn a large amount of interest without paying tax. For example, someone with no other income could potentially earn over £18,000 in interest (combining the Personal Allowance, starting rate, and PSA) without any tax due!
It’s also worth noting that interest from tax-free accounts like Individual Savings Accounts (ISAs) does not count towards any of these allowances. ISA interest is always tax-free on its own. So, if you’re trying to maximize tax-free interest, an ISA is a powerful tool in addition to the allowances above.
Do I Need to Pay Tax on My Savings Interest?
If your savings interest stays within the allowances described above, you won’t have to pay any tax on that interest – and you usually won’t need to do anything extra, either. Banks and building societies pay interest without deducting tax (unlike years ago when they automatically took 20% off). They will report the interest you earn to HMRC after each tax year.
If you do earn more interest than your allowance cover, you will need to pay tax on the portion over the allowance. How this happens is generally automatic for most people:
- HMRC Tax Code Adjustment: If you’re employed or receive a pension (i.e. you pay tax through PAYE), HMRC will usually adjust your tax code to collect the tax due on your savings interest. They do this by estimating your interest income (often based on the previous year) and tweaking your code so that a bit more tax is taken from your salary or pension to cover the savings-interest tax. This means you likely won’t need to fill out any extra forms – it’s handled via your PAYE code.
- Self-Assessment: If you have a lot of savings interest (for example, £10,000 or more in a year) or other untaxed income, HMRC might ask you to file a Self-Assessment tax return to declare your interest. Also, if you’re self-employed or otherwise already filing a tax return, you’d include any taxable interest there. On the tax return, you will list your total interest received, and the calculation will ensure that any interest above your allowances is taxed at the appropriate rate.
Important: Keep an eye on how much interest your savings are generating, especially if you have large deposits or high interest rates. If you suspect you’ll go over your tax-free allowances, be prepared for a tax bill on the excess interest. It might be as simple as a change in your tax code, but you don’t want to be caught off guard by a lower take-home pay or an unexpected bill.
Most people with moderate savings won’t ever hit these limits – as we mentioned, most savers don’t pay any UK savings tax thanks to these allowances. But if you do, it’s manageable: just stay informed and set aside a portion of the interest in case tax becomes due.
Tips to Maximise Your Tax-Free Savings
Everyone likes the idea of earning interest without paying tax. Here are some smart tips to make the most of the available allowances and keep your savings interest as tax-efficient as possible:
- Utilise ISAs: Every UK resident gets an annual ISA allowance (currently around £20,000 per year) that you can put into an ISA. Money in an ISA grows tax-free, and the interest doesn’t count towards your Personal Savings Allowance. By using ISAs for your savings or investments, you can earn interest (or investment returns) completely tax-free beyond the PSA limits.
- Share Savings with Your Spouse or Partner: If you’re married or in a civil partnership and one of you has spare allowance or is in a lower tax band, consider splitting savings between you. Each person has their own £1,000/£500 PSA, as well as their own Personal Allowance and starting rate band. By spreading your savings, a couple can effectively double the amount of interest that can be earned tax-free together.
- Choose the Right Accounts: Pay attention to how and when interest is paid on different savings products. Some accounts pay interest yearly or at maturity, which could give you a large lump sum of interest all at once and potentially push you over your allowance in that year. If you’re near the PSA limit, consider opting for accounts that pay interest monthly (so you can monitor and manage your interest) or spreading your savings across multiple accounts or into an ISA. This way, you avoid a big interest spike from one account that could tip you over the threshold.
- Plan for Tax if Needed: If you are fortunate enough to earn interest above the tax-free limits, plan for it. Keep a record of the interest you receive and be ready to report it if required. The tax on the portion of interest above your allowances will be at your normal rate – knowing your potential bill helps you avoid surprises. If you’re unsure how much you might owe, an accountant can help you estimate it and guide you on how to pay it smoothly.
By taking these steps, you can maximise your after-tax returns on your savings. The goal is to ensure as much of your interest as possible stays in your pocket.
Get Professional Help to Make the Most of Your Savings
Understanding tax rules can be confusing, but you don’t have to figure it all out alone. Our accounting firm is here to help you navigate UK tax allowances and make smart decisions about your money. Whether you have questions about your Personal Savings Allowance or need guidance on broader tax planning, our experts can provide personalised advice to suit your needs.
Ready to maximise your savings and minimise your tax? Contact us today to speak with one of our friendly accounting professionals. We’ll help ensure you’re taking full advantage of all HMRC allowances and not paying a penny more in tax than necessary. Let us handle the tax complexities while you enjoy peace of mind and more money in your pocket.