Sarah Bradford outlines how savings income is taxed and highlights options for earning savings income tax-free.
Rising interest rates and frozen tax thresholds may mean that you will now be liable for tax on your savings income when previously you were able to enjoy it tax-free. However, it is still possible to enjoy some savings income tax-free, regardless of the rate at which you pay tax.
Banks notify HMRC of interest earned on bank accounts. If you are taxed through PAYE, HMRC will adjust your tax code to collect any tax due. If you are taxed through self-assessment, you should include the interest on your tax return. The associated tax will be paid through the self-assessment system.
Complicated rules
The rules governing the taxation of savings income are quite complicated, as the allowances that are available depend on the rate at which you pay tax and what other income you have. In addition, savings income from certain accounts can be enjoyed tax-free.
Savings income from accounts other than tax-free savings accounts (see below) is tax-free to the extent that it exceeds the available allowances (either the personal allowance where not used elsewhere or, where available, the personal savings allowance). Once these allowances have been used up, to the extent that it does not fall in the savings starting-rate band (where applicable), savings income is taxed at your marginal rate of tax.
Personal savings allowance
Basic and higher-rate taxpayers can enjoy a personal savings allowance in addition to their personal allowance. For 2024/25, the personal savings allowance is set at £1,000 for basic-rate taxpayers and at £500 for higher-rate taxpayers. Additional rate taxpayers do not receive a personal savings allowance. Where the personal savings allowance is available, interest from savings is tax-free where it is sheltered by the allowance.
Inflationary pay rises combined with frozen tax thresholds may mean that your personal savings allowance in 2024/25 is less than in 2023/24. Further, if you have moved into the additional rate band for 2024/25, you will no longer receive a savings allowance. This may mean that you will now need to pay tax on your savings income where previously it was covered by the allowance.
Example 1: From basic to higher rate taxpayer
In 2023/24, Anna had a salary of £50,000. As a result of a pay rise, her salary in 2024/25 is £53,000. She receives interest on her savings of £700.
In 2023/24, she was a basic-rate taxpayer and able to benefit from a personal savings allowance of £1,000. Consequently, there was no tax to pay on her savings income.
However, because of her pay rise, she is a higher-rate taxpayer in 2024/25. This means that she is only entitled to a personal savings allowance of £500. As her savings income exceeds this, she will be taxed on the excess of £200 at her marginal rate of 40%; a tax bill of £80.
Rising interest rates may mean that you are achieving a better return on your savings, meaning that your savings income is higher than in previous tax years. More savings income combined with a reduction in, or an elimination of, your personal savings bill may mean a tax bill on your savings income.
Example 2: Increased savings income
Aiden is a higher-rate taxpayer. In 2023/24, he had savings income of £450. However, because of rising interest rates, he receives savings income of £675 in 2024/25. As a higher-rate taxpayer, he is entitled to a personal savings allowance of £500 in both 2023/24 and 2024/25.
In 2023/24, the interest on his savings was less than his personal savings allowance, so there was no tax to pay. However, in 2024/25, as the interest on his savings exceeds his personal savings allowance by £175, he must pay tax of £70 on his interest (i.e., £175 @ 40%).
Savings starting rate
If your other taxable income (excluding any savings income) is less than £17,570, you will be able to benefit from the savings starting-rate band and the associated savings starter rate of tax, which is set at 0% for 2024/25. The savings starting-rate band is available in addition to the personal savings allowance.
The savings starting-rate band is set at £5,000, but is reduced pound-for-pound by taxable non-savings income in excess of the personal allowance.
The availability of the savings starting-rate band and personal savings allowance is illustrated by the following examples.
Example 3: No tax payable on savings income
Betty has pension income of £10,000 a year. Aside from interest on her savings, she has no other income in 2024/25. As Betty’s non-taxable savings income does not exceed her personal allowance, she is able to benefit from the savings allowance in full, allowing her to enjoy an additional £5,000 of tax-free income on top of that sheltered by her remaining personal allowance and personal savings allowance.
Consequently, as long as her savings income does not take her into the higher-rate band, she can earn savings income of £8,570 tax-free (remaining personal allowance of £2,570 plus savings starting-rate band of £5,000 plus personal savings allowance of £1,000), in addition to that held in tax-free savings accounts.
Example 4: How much tax-free savings?
Bryan has pension income of £13,500 in 2024/25. He has no other non-savings income.
As his non-savings income exceeds his personal allowance, his savings starting-rate band is reduced by the excess of £930 (i.e., £13,500 - £12,570). Consequently, Bryan is entitled to a reduced savings starting-rate band of £4,070 (i.e., £5,000 - £930) in addition to his personal savings allowance (as long as his savings income does not push him into the higher-rate band).
Consequently, he can enjoy savings income of £5,070 (i.e., savings-rate band of £4,070 plus personal savings allowance of £1,000) tax-free in addition to that from tax-free savings accounts.
Example 5: Personal savings allowance: basic rate taxpayer
Bella has a salary of £35,000. As her taxable income exceeds her personal allowance by more than £5,000, she is unable to benefit from the savings starting-rate band.
However, as a basic-rate taxpayer, she can benefit from a personal savings allowance of £1,000.
Example 6: Personal savings allowance: higher rate taxpayer
Brad has a salary of £75,000. As his taxable income exceeds his personal allowance by more than £5,000, he is unable to benefit from the savings starting-rate band.
However, as a higher-rate taxpayer, he can benefit from a personal savings allowance of £500.
Example 7: No personal savings allowance
Billy has trading profits of £200,000. As he is an additional-rate taxpayer, he is unable to benefit from the savings starting-rate band or a personal savings allowance.
Maximum tax-free savings income
As the savings-rate band is available in addition to the personal allowance and personal savings band, if your only income is savings income, you can enjoy savings income of £18,570 tax-free in 2024/25. The income is sheltered by the personal allowance of £12,570 and the personal savings allowance of £1,000 (available to basic-rate taxpayers) – a total of £13,570. A further £5,000 falls within the savings starting-rate band, and is taxed at 0%.
Spouses and civil partners each have their own personal savings allowance and savings starting rate band. Therefore, it makes sense to organise investments to make maximum use of these (e.g., if one spouse has no other income or their other income is less than their personal allowance, by putting savings in their name to access the savings starting-rate band). Where savings are held in a joint account, each spouse or civil partner is taxed on 50% of the income.
Consider an ISA
If you are now paying tax on your savings income for the first time, you may wish to consider investing in an individual savings account (ISA).
Individuals can save up to £20,000 in an ISA each tax year (of which up to £4,000 can be in a lifetime ISA). Tax is not payable on any interest on cash held in an ISA (or on income and gains if you have a stocks and shares ISA).
Alternatively, consideration could be given to investing some savings in shares to take advantage of the dividend allowance (set at £500 for 2024/25) to receive tax-free dividends instead of taxable interest.
Practical tip
Rising interest rates, pay rises and frozen thresholds may mean you now need to pay tax on your savings income. It is prudent to review the position, and consider holding some of your savings in tax-free accounts, such as ISAs.
