- Number of people having to pay tax on their savings will almost double over two years
- Almost 2.1 million people are expected to pay tax on their savings this year
- Almost 1 in 10 higher-rate taxpayers are expected to pay the tax now
- Increased ISA use could be why the figures are lower than the amount previously forecast by the government
- Savers should beware tax traps that could land them an unexpected bill from HMRC
The number of people having to pay tax on their savings will almost double over two years to the end of the current tax year, a Freedom of Information request from AJ Bell can reveal. More people will be pushed into paying tax on their savings as interest rates have risen and people hit their tax-free limit.
The Personal Savings Allowances protects many people from paying tax on their savings interest, but it has remained at current levels since it was introduced more than eight years ago. The Personal Savings Allowance currently stands at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Additional rate taxpayers get no exemption and pay tax on all cash interest they receive outside a tax wrapper.
The figures show that almost 2.1 million people are expected to pay tax on their savings this year, up from around 650,000 just three years ago. The number of basic-rate taxpayers being hit with the tax will near 1 million people, up from just half a million in 2022/23.
However, these figures are lower than the initial amount forecast by the government. An FOI last year showed that the government projected 2.7 million people would be hit with tax on their savings in the 2023/24 tax year, which has now been revised down to 1.9 million. This could be down to many factors, including more people using a cash ISA to protect their savings from tax, fewer people switching to higher interest savings accounts, and interest rates not being as high as HMRC initially projected.
Regardless, it still means that around 1 in 30 basic-rate taxpayers are expected to pay tax on their savings this year, up from less than 1 in 100 three years ago. Almost 1 in 10 higher-rate taxpayers are expected to pay the tax now, compared to around 1 in 25 just three years ago.
Laura Suter, director of personal finance at AJ Bell, comments:
“Previously the majority of people didn’t need to worry about paying tax on their savings, as interest rates were low and the Personal Savings Allowance was sufficient to cover most people. But now a tricky combination of interest rates rising, cash ISAs being shunned for decades, more people moving into higher tax brackets and seeing their Personal Savings Allowance cut, and the tax-free allowance being frozen means lots of people are being dragged into the tax.
“The figures are lower than previous estimates from the government, which is likely due to a number of factors. We know more savers have used cash ISAs to protect their savings from tax, thanks to high-profile campaigns about the number of people who are likely to be hit with tax bills. Bank of England data shows that April was a record-breaking month for cash ISAs, with £11.7 billion being put in the accounts, marking the highest amount since ISAs were introduced in 1999. This trend has continued, with more people using ISAs since tax-year end to protect their cash from unwanted tax.
“Previously savers often had to make a decision between getting the highest interest rate with a non-ISA account and using a cash ISA, but ISA rates have more closely matched standard savings rates in recent years, removing one of the barriers to using an ISA.
“However, another reason for the drop in the figures could be that lots of cash savers are still apathetic when it comes to their savings. Despite interest rates having soared many people have left their money sitting in old savings accounts earning very little or no interest. Bank of England data shows that £252 billion of money is sitting in accounts earning no interest, and there will be much more in accounts with below-average rates. While this means people are less likely to hit their tax-free limit for savings income, it does mean they aren’t maximising their returns on cash.
“For those who have ditched and switched to get better rates and are now going to be hit with tax on their money, they often won’t realise until a brown letter lands on their doormat. Those filling out a self-assessment tax return will declare any savings interest, and subsequent tax due. But, for those taxed under PAYE, HMRC will calculate any tax due based on information sent to them by banks and building societies. It means many taxpayers will find there is a deduction made from their payslip each month, often before they’ve even realised they owe any money to the taxman.”
How to beat the savings tax traps
“Although the Personal Savings Allowance protects lots of people from paying tax on their savings it’s clear millions of people are still falling into a tax trap.
“Lots of people will breach the tax free limit on savings income – maybe without knowing. The good news is there are way round this, like using an ISA, or dividing your savings up between you and your partner to take advantage of their own savings allowance, or a lower tax rate.”
- Trap 1: Fixed rate accounts
“Lots of people are picking fixed-rate savings accounts at the moment, locking their money up for one, two, three or even five years to get a guaranteed interest rate. However, many people won’t realise that this could leave them with a tax headache in the future. You are taxed on the interest on your savings when it is accessible by you. So if you pick a fixed-rate savings account that pays out all the interest at maturity, for tax purposes all of that interest will be counted in one tax year. This means that the interest from just one account could take you over your Personal Savings Allowance on its own.
“To get around this trap you could opt for an account where the interest is paid out monthly or annually, meaning it is spread across different tax years. Or you can opt for a fixed-term ISA savings account, where you won't pay any tax on the interest.”
- Trap 2: Tax on your child’s savings
“A little-known rule means that you might have to pay tax on interest that’s earned on your child’s savings. This sneaky tax rule means that once a child earns £100 or more in interest on money that has been gifted by parents, it is taxed as though it is the parent’s money.
“This won’t be a problem if you haven’t earned much taxable interest yourself, but if you’re near (or already over) your Personal Savings Allowance you’ll be hit with unexpected tax.
“One way around it is to use a Junior ISA account, where all interest will be protected from tax and won’t count towards the parents’ limit. Or you can carefully split the money you give between parents, to ensure that you are making equal payments to children.
- Trap 3: Tipped into the next tax bracket
“The Personal Savings Allowance is cut in half or wiped out altogether if you move into the next income tax bracket. So if you earn more than £50,270 (even by £1) you’ll become a higher-rate taxpayer and see your Personal Savings Allowance cut from £1,000 to £500. And if you earn more than £125,140 you’ll become an additional-rate taxpayer and see your Personal Savings Allowance drop to nothing – meaning that all your savings income will be taxed at 45%.
“Something lots of people aren’t aware of is that savings interest counts towards this limit. One way around this is using an ISA for your savings, as then the interest won’t count for income tax purposes. Alternatively, you could pay some of your income into your pension, which could bring you back into a lower tax bracket. Another option is moving cash savings into an account in your partner’s name, if they pay tax at a lower rate than you or haven’t used up their Personal Savings Allowance yet.”
- Trap 4: Joint savings account
“Lots of people might have savings accounts in joint names, but they may not realise that this means the interest is split 50:50 between the two account holders. It could mean you have taxable interest that you hadn’t realised. For example, a joint savings account that generates £1,000 interest each year would be split so that each partner has £500 interest to count towards their Personal Savings Allowance.
“If one half of a couple is a lower earner, and so in a lower tax bracket, it could make sense to move the savings into an account in their name, as any interest that’s taxable will be paid at a lower rate. if one half hasn't exhausted their Personal Savings Allowance you could move savings into their name to maximise their tax-free amounts.”
- Trap 5: Not realising it isn’t just savings interest that counts
“With an investment fund, if the fund invests more than 60% in bonds and cash, then payments from the fund are classed as interest rather than as dividends. Your investment platform or provider will usually send you a tax statement each year to show you how much you’ve made in interest in that tax year, to help with your calculations.
“The easiest way to avoid this is to use a stocks and shares ISA for your investments, or an Innovative Finance ISA for any peer-to-peer investments you have, so no tax will be due.”
