Tax on Savings Explained
Updated on Wednesday 9 June 2021
All British taxpayers have what is called a ‘Personal Savings Allowance’, meaning they can earn interest on their savings up to a certain amount without having to pay tax on that allowable interest.
What’s more, if you’re a low earner, there is a ‘Starting Rate for Savings’, which means you’ll pay no interest on any savings up to £5,000.
As there is much confusion amongst savers about tax on savings, we’ve put together this comprehensive guide explaining why savings are taxed, how the tax is calculated, how it's paid to HMRC and how to protect your savings from being heavily taxed.
Why is tax placed on your savings?
According to a report on the Institute of Fiscal Studies’ website, tax on savings “plays a central role in how economists evaluate a tax system” to:
- Avoid having a ‘comprehensive income tax’, ‘expenditure tax’ or ‘consumption tax’
- Equalise the tax payable on a lifetime of income instead of just an annual income
- Distinguish between personal income and company profits
- Balance savings in the economy and how savings are assigned
- Influence savers’ decisions and welfare, particularly for retirement or unemployment.
Like all other UK taxes, tax on savings’ interest will be used by the government to help fund essential public services like the NHS, the Department for Education and the Ministry of Defence, to name but a few.
How are your savings taxed?
How your savings are taxed depends on:
- The type of savings you have
- The Starting Rate for Savings (SRS)
- Your Personal Savings Allowance (PSA)
1. Type of Savings
Most types of savings accounts require payment of tax on any interest accrued, subject to your income-based entitlement to SRS and PSA.
However, everyone in the UK is entitled to a tax-free savings limit of £20,000 using a tax-free ISA, including additional rate taxpayers. You can also avoid paying tax on some National Savings & Investments’ products and children’s accounts.
The tax payable on share-based investments also differs to other types of savings and for 2021/2022 you are entitled to income from share dividends up to £2,000 a year. The amount of tax payable on dividends worth more than £2k varies according to your income tax band. The tax charged for earners falling into the basic rate tax band is 7.5%, or the higher rate tax band is 32.5% and the additional rate tax band is 38.1%.
2. The Starting Rate for Savings (SRS)
If you are on a low income and earn *£17,570 a year or less, you are entitled to the SRS.
The Starting Rate for Savings for 2020/21 is £5,000 and means you can earn interest on your savings up to the value of £5,000 before you are obliged to pay any tax.
*The minimum income amount is higher for anyone claiming Blind Person’s Allowance (£20,090) or Married Couple’s Allowance (dependent on circumstances).
3. Your Personal Savings Allowance (PSA)
In addition and similar to the SRS, all UK taxpayers have a PSA according to their income tax band, meaning you are entitled to tax-free savings according to how much you earn.
The PSA for 2021/2022, according to your income tax band and income is as follows:
Taxpayer Band |
Income Threshold |
PSA |
|
Basic Rate @ 20% |
£12,571-£50,270 |
£1,000 |
|
Higher Rate @ 40% |
£50,271-£150,000 |
£500 |
|
Additional Rate @ 45% |
£150,000+ |
£0 |
How does HMRC collect tax on savings?
In April 2016, the tax rules changed meaning that interest on savings is paid without tax being deducte,d putting the onus on you to notify HMRC about any tax due to them.
Once you’ve notified HMRC of your tax obligation, if you’re employed or get a state pension, they’ll usually change your tax code for the next year so you pay your savings’ interest tax off monthly, avoiding you having to pay a lump sum.
If you’re self-employed and submit a Self Assessment Tax Return, you need to detail any interest you’ve earned on savings on your Tax Return.
If you’re none of the above, your bank or building society will notify HMRC how much interest you’ve accrued and HMRC will let you know if any tax is due and how to pay.
Does HMRC know about my savings?
Yes, if your savings are held by a bank or building society, they can let HMRC know how much interest you’ve earned on your savings.
Also, if HMRC is suspicious about a taxpayer not disclosing pertinent information about this income or savings, they have the power to make personal checks about you with your bank or other financial institutions by issuing a ‘third party notice’. In July 2020, HMRC created what is known as a ‘financial institution notice’ to speed up the process of accessing information about a taxpayer.
Do I have to declare savings interest to HMRC?
Yes, if you earn interest over your Personal Savings Allowance on savings (excluding ISAs) or any other way, then it is your responsibility to notify HMRC who will arrange for you to pay tax, usually by amended your tax code.
What is the personal savings allowance for 2020/21?
The personal savings allowance for basic rate taxpayers in 2020/21 is £1,000 and £500 for higher rate taxpayers. If you’re an additional rate taxpayer there is no personal savings allowance.
Note: The income threshold for taxpayer bands has changed slightly for 2021/22 - see below for details.
Do I have to pay tax on my savings?
Not necessarily - tax is only payable on the interest earned by your savings that exceed your Personal Savings Allowance (and/or Starting Rate for Savings if you’re on a low income).
You can also save up to £20,000 in a tax-free ISA.
There are also certain National Savings & Investments’ products and children’s accounts where no tax is payable on interest earned.
How much tax is placed on my savings?
How much tax you pay on your taxable savings depends on your income-related taxpayer band.
Those on a low income are entitled to a Starting Rate for Savings (SRS) allowing them to earn a larger sum of tax-free interest on their savings before having to pay any tax.
And those on an average to higher rate income tax band still get a Personal Savings Allowance (PSA) meaning they can earn a certain amount of interest on their savings before paying tax too.
It’s only ‘additional rate’ high-income earners that have no tax-free allowance, as demonstrated in the table below.
Taxpayer Band |
Income (not savings) |
Tax-free interest |
Allowance |
|
0 tax |
£0-£12,570 |
£5,000 |
SRS |
|
Basic Rate/Low Income |
£12,571-£17,570 |
£5,000 + £1,000 |
SRS & PSA |
|
Basic Rate |
£17,571-£50,270 |
£1,000 |
PSA |
|
Higher Rate |
£50,271-£150,000 |
£500 |
PSA |
|
Additional Rate |
£150,000+ |
£0 |
N/A |
Source: moneyadviceservice.org.uk
How can I avoid paying taxes on my savings?
In addition to using any PSA or SRS allowance you may be entitled to, you can avoid paying taxes on your savings by wisely choosing certain methods of saving or investing that are tax-exempt:
Individual Savings Accounts (ISAs) - you can collectively save up to £20,000 tax-free in one tax year into a stocks and shares ISA, a cash ISA, a Lifetime ISA and/or an innovative finance ISA. You can also separately pay up to £9,000 into a tax-free Junior ISA and this will not affect your own personal ISA allowance of £20,000.
Child Trust Fund - this is no longer available but you can instead apply for a Junior ISA. If you have an existing Child Trust Fund, you can pay up to £9,000 every tax year into this fund. You can also transfer savings straight from a Child Trust Fund to a Junior ISA.
National Savings and Investments (NS&I) cash ISA or Premium Bonds - NS&I offers a government-backed, tax-free Direct ISA, Junior ISA or Premium Bonds as savings options.
Pension savings - you are entitled to tax relief on pension contributions up to £40,000 for the year 2021/22. When you take money out of your pension, 25% is tax-free and you pay tax on the remaining 75%. You also still continue paying tax on savings when retired or reach State Pension age on anything above your Personal Savings Allowance.