Paying tax on small savings 

We all know that the taxman takes a cut when we earn money – through income tax – and when we spend it, through VAT.

But we might forget he takes a share when we save it too.

The money your savings makes in interest could be subject to tax, and you might find that your thrift could land you with a surprise tax bill.

The problem is getting worse

The taxman has been quietly helping himself to a share of the interest our savings earned for generations. The bank or building society where you put your spare cash would automatically deduct a proportion of the interest equivalent to basic rate tax on the interest your deposit earned. Things were worse if you were a higher or top rate payer. You would need to declare your interest earnings and pay additional deductions through your tax return.

But things became a little more complicated in 2016. Then Chancellor George Osborne introduced the personal savings allowance to encourage saving. Since then, savers have been able to grow some of their money tax free.

But the allowance was tied to your tax bracket. For the 2023-24 tax year the allowances are:

  • Basic-rate taxpayers – £1,000
  • Higher-rate taxpayers – £500
  • Additional-rate taxpayers – £0

In other words, a basic rate taxpayer could earn £1,000 in interest and have nothing to pay the taxman. A higher-rate taxpayer can only earn £500 in interest before they are taxed on it. Additional-rate payers receive no allowance at all.

Back in 2016, interest rates stood at just 0.5% and a basic rate saver would need more than £100,000 on deposit to trigger a tax bill. Interest rates are now very much higher, which means savings are very much more rewarding – and savers are being hit with tax bills on accounts containing little more than £8,000, as rates have shot up.

Higher interest rates mean more returns on your savings – but they mean more chance of being liable for tax on those returns.

The hidden costs of saving

The best saving rates for one-year fixed bonds are now heading past 6%, dramatically shrinking how much money can be saved before the taxman comes knocking.

A basic-rate taxpayer would incur tax on their interest on pots of £16,667 or more. A higher-rate taxpayer would only need to save £8,334 in the best one-year fixed rate bond before they breached their personal savings allowance.  Additional-rate taxpayers don’t receive a personal savings allowance, so if you earn more than £125,140 each year, you’ll need to pay tax on all your savings interest.

The tax makes a big difference to the return on savings. You pay tax at the same rate as income tax, which is 20% for most people. If you are a higher-rate taxpayer the 20% becomes 40%. That drops the effective interest rate you’re earning on that 6% bond to 3.6% for a higher-rate taxpayer, or 4.4% if you’re a basic-rate taxpayer. 

In 2023-24, the higher-rate tax threshold in most of the UK kicks in at £50,270, the same as in 2022-23. More and more people are finding that they are paying tax on their savings, especially if wages inflation is pushing them into the higher rate bracket. 

What can you do about the tax on saving?

There is an extra tax break to helps those on a low income pay either no tax or reduced tax on savings. This £5,000 ‘starting rate for savings’ means anyone with total taxable income under the personal income tax allowance plus £5,000 will not pay any tax on savings. 

But for the rest of us, we may need to look at our savings strategy. If you are in danger of paying tax on your small savings, it might be time to look at an ISA as a home for your spare cash.

A Cash ISA can be as easy to use as a savings account, and you can pay in up to £20,000 a year – although you will lose out if you have to make withdrawals. But it has a big advantage over traditional savings accounts – the taxman will not be able to help himself to any of the interest your money earns.

To find the most suitable Cash ISA for your needs, and to ensure that your contribution to the taxman is not a penny higher than it has to be, it makes sense to get expert advice.

Call us at Continuum today, and we will be happy to provide it. 

The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.

The Financial Conduct Authority does not regulate taxation advice and deposit accounts.

When investing, your capital is at risk.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. We recommend that the investor seeks professional advice on personal taxation matters.

Book a Meeting

If you want to get a free consultation without any obligations, fill in the form below and we'll get in touch with you.

    Sign-up to our free weekly online publication

    How can we help you?
    Scan the code