After years of low interest rates in the UK, the Bank of England (BoE) began raising the base rate at the end of 2021 to help reduce inflation.
As you can see from the chart below, the base rate – the interest rate the BoE charges other banks and lenders when they borrow money – peaked at 5.25% in August 2023.
Source: Bank of England
The BoE has made several cuts to the base rate since August 2024, yet, interest rates remain relatively high – the rate as of 20 February is 4.5%.
While you might be enjoying seeing your savings grow as they accumulate more interest, a higher base rate could also have unwelcome tax implications.
Indeed, research published by MoneyAge has revealed that more than 6 million accounts could be at risk of breaching the Personal Savings Allowance (PSA), potentially resulting in an unexpected tax bill.
Read on to learn more about your PSA and find out why you may need to pay tax on your savings interest. Then discover four practical tips for mitigating a potential tax bill.
You can earn a certain amount of tax-free interest on your savings each tax year
PSA thresholds were introduced in 2016 to let savers earn a limited amount of interest from non-ISA savings without incurring a tax charge.
Your PSA depends on your Income Tax bracket, as shown in the table below:
You’ll usually pay tax at your marginal rate of Income Tax on any interest that exceeds your PSA.
Higher interest rates and a frozen Personal Savings Allowance could increase your tax liabilities
Higher interest rates could mean that you use up your PSA much more quickly than in previous years when the base rate was lower.
For example, using figures published by Moneyfacts as of 20 February, the highest interest rate available on an easy access savings account was 4.75%.
If you’re a higher-rate taxpayer, with this level of interest, you’d only need to have just under £10,600 in savings for one year before you exceed your PSA and face a tax charge.
What’s more, the PSA remains at the initial levels set in 2016. So, as the cost of living has increased over time, it has become easier to exceed your PSA than it was before.
3 practical tips for paying less tax on savings interest
Fortunately, there are steps you could take to reduce the amount of tax you pay on savings interest.
1. Use your full annual ISA allowance
Every tax year you can save up to ÂŁ20,000 (2024/25) into a single adult ISA or split across multiple accounts, without incurring Income Tax, Capital Gains Tax (CGT), or Dividend Tax.
This allowance is separate from your PSA. So, you could benefit from the tax advantages of saving into an ISA, regardless of your tax band or how much of your PSA you’ve already used.
Additionally, you won’t pay Income Tax on any withdrawals you make from an ISA.
So, making the most of your annual ISA allowance could be an effective way to minimise the amount of tax you pay on savings interest.
Saving as a family could also be beneficial, as each individual is entitled to an annual ISA allowance. So, as a couple, in the 2024/25 tax year, you could save up to £40,000 tax-efficiently in ISA wrappers. As such, if you’ve used up your full allowance, you might want to consider paying into your spouse or partner’s ISAs.
You can also pay up to £9,000 a year (2024/25) into a Junior ISA for a child under the age of 18 (this would not affect your personal ISA allowance). The child can take over management of this account when they turn 16, but they can’t withdraw any funds until they are 18.
2. Invest in Premium Bonds
Premium Bonds are a type of savings account, but rather than paying you interest like a traditional account, each month you’re given the chance to win prizes worth up to £1 million.
One of the biggest attractions of Premium Bonds is that all prizes are tax-free.
However, it’s important to note that there is no guarantee you’ll win anything. In fact, according to National Savings and Investments (NS&I) the odds of winning a prize are 21,000 to 1 for every £1 bond. Statistically, this means you’d need at least £22,000 of Premium Bonds to average a prize a month.
However, Premium Bonds are backed by the Treasury, making them a relatively secure option that might be worth exploring if you’re seeking tax-efficient ways to save.
3. Make additional pension contributions
Your pension is one of the most tax-efficient ways to save. This is because your pension wealth grows free from Income Tax and CGT.
What’s more, you can receive government tax relief on any pension contributions you make up to £60,000 – your Annual Allowance for the 2024/25 tax year – or 100% of your earnings, whichever is lower.
You may have a reduced Annual Allowance if your earnings exceed certain thresholds, or you have already flexibly accessed your pension. On the other hand, your Annual Allowance might be higher for the current tax year if you have carried forward unused allowances from previous tax years.
Making full use of your Annual Allowance by increasing your pension contributions could help you grow your wealth tax-efficiently and build a healthy savings pot for the future.
However, you can’t usually access your pension funds until you reach 55 (rising to 57 in 2028). So, before you start making additional pension contributions, make sure that you have enough accessible savings to cover your short- and medium-term needs.
Get in touch
If you’re eager to maximise your tax-efficient savings, we can help.
Please get in touch by emailing info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can assist you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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