- Despite expected interest rate cut this week, millions of savers are being hit with tax on their savings interest
- Higher-rate taxpayers with cash in the best easy-access account in December 2021 (before the current rate hiking cycle) could have up to £77,000 before hitting their tax-free limit
- This limit has dropped to £9,800 today
- Basic-rate taxpayers could have had £154,000 in the best easy access account two years ago before getting taxed – which has shrunk to just £19,600 today
- AJ Bell FOI shows 2.64 million people are to be hit with tax on savings in the 2025/26 tax year
Laura Suter, director of personal finance at AJ Bell, comments:
“Even though we’re expecting another interest rate cut this week, millions of savers will still be hit with a tax bill for their savings interest. Our FOI this week showed that one in 15 taxpayers are expected to pay some tax on their savings in the current tax year. And HMRC estimates that Brits will earn around £20 billion from interest on non-ISA cash accounts this year – leading to a £6 billion tax bill for the nation.
“Many won’t realise that even having relatively modest sums in their savings accounts could land them with a tax bill. The current top easy-access rate is 5.1%, meaning that a basic-rate taxpayer only needs to have £19,600 in savings before they hit their tax-free limit. For a higher-rate taxpayer that sum halves to just £9,800 before they will face tax on their savings, assuming it’s in the top paying account. This is a stark contrast to the £154,000 of savings a basic-rate taxpayer could have had in December 2021, before interest rates started to rise.
“As interest rates have been cut from their peak, many savers may assume the problem with being hit with a tax bill for their cash savings is in the rear-view mirror, but savings rates are still far higher than years ago, meaning millions will have to pay tax.
“Frozen tax bands have pushed far more people into an unexpected tax bill – as once you hit the higher-rate tax band your tax-free personal savings allowance is cut in half to £500. If you hit the additional rate band of £125,140 you’ll pay 45% tax on all your savings income – as the personal savings allowance is cut to nothing.
“When base rate was 0.1%, if your savings were earning that amount of interest, a basic-rate taxpayer would need to have £1 million in cash savings to hit their £1,000 tax-free limit. However, fast forward to today and with the top easy-access savings account now paying 5.1%, that same basic-rate taxpayer would only need to have £19,600 in savings to hit the limit. What’s more, if that basic-rate taxpayer had seen their income rise in the past few years and had tipped over into the higher-rate income tax bracket, they would only have a £500 tax-free savings limit, meaning they would need to have just £9,800 in savings before they hit their new, lower limit.”
Why ISAs still matter
“Cash ISAs used to be the go-to for savers looking to shield their interest from tax. But since the personal savings allowance came into play, many turned their backs on ISAs in favour of simpler, often better-paying, non-ISA accounts. That switch is now proving costly for some, as they’re finding it difficult to shift large balances into an ISA all at once. While the £20,000 annual ISA limit is fairly generous, it’s not hard to max out if you’ve built up significant savings outside an ISA over the years. Plus, with Cash ISAs sometimes offering lower interest rates, savers face a balancing act: choose a higher-rate non-ISA account and pay tax on the interest, or go for the tax-free benefits of an ISA and potentially accept a lower return.
“It’s also a good time to rethink how much cash you actually need. Keeping money in cash makes sense for near-term spending or as an emergency buffer. But once you’ve covered those bases, investing might offer better long-term returns. Historically, stock markets have outperformed both cash savings and inflation over time.”
Older savers to be hit
“Older savers who are nearing retirement are particularly at risk of an unwanted tax bill for their cash savings. Many will have built up large cash reserves to spend in retirement – not wanting to take risk with the money by investing it so close to their retirement date. Once in retirement many retirees will also have decent cash pots to live off, alongside their other pension income. If these cash piles are outside an ISA wrapper, they could face chunky tax bills for the money.
“On top of that, frozen tax bands mean many more pensioners will be pushed into paying income tax. The rising state pension is taking up a decent chunk of retirees’ personal allowance now, meaning that extra pension income could easily push them into basic-rate tax. This means that savings income exceeding £1,000 a year would be taxed at 20%. Those who are earning lots of interest on their savings or who are already near the next tax band could find that the savings interest itself tips them into the next tax bracket.
“What’s more, it will take a long time for these savers to move their money into an ISA. Someone with £100,000 today in cash savings would need until 2030 to get that whole pot, plus future interest, into an ISA wrapper – assuming they haven’t already used their ISA allowance this tax year.
“Retired couples should be savvy about how they organise their finances generally, and specifically their cash savings. Moving cash to the partner with the lowest income tax band is a smart way to easily save on tax, if you have one basic-rate taxpayer and one higher-rate payer, for example. Equally, making sure both partners are using their tax allowances to the full, such as the personal savings allowance and ISA limits can help to reduce tax bills.”
