Savers are set to pay more than £10 billion in tax on interest – Here’s how to cut your bill

In the past few years, you’ve likely seen news stories about higher interest rates and how they might affect your finances.

For example, if you’re a homeowner, you may have experienced a sharp increase in your monthly mortgage costs. Indeed, according to the Office for National Statistics (ONS), the average monthly cost of a new mortgage rose by 61% in the year to December 2022.

Yet, while high interest rates may have increased your mortgage costs, you might have benefited from a better interest rate on your savings too. This could mean that you’ve seen more growth in your cash savings in recent years.

If so, you may want to consider how much tax you’re likely to pay on your interest, as MoneyAge reports that savers are expected to collectively pay £10.4 billion in 2024/25.

Read on to learn why this is and three ways you could potentially reduce your bill.

You could pay tax on any interest that exceeds your “Personal Savings Allowance”

If you hold a portion of your wealth in cash savings, it’s important to consider how any interest is taxed.

Your “Personal Savings Allowance” (PSA) is the amount of interest you can earn from non-ISA savings before paying tax. You typically pay tax at your marginal rate of Income Tax on any interest that exceeds your PSA.

In 2024/25, the PSA is:

• £1,000 if you’re a basic-rate taxpayer
• £500 if you’re a higher-rate taxpayer
• £0 if you’re an additional-rate taxpayer.

While interest rates are higher, you may receive more interest, and so be more likely to exceed your PSA and pay tax.

The average easy-access cash savings account interest rate was 5.2% in August 2024

Inflation is one of the main reasons that interest rates have risen in recent years. As the world recovered from the Covid-19 pandemic, and the war in Ukraine caused a spike in fuel prices, inflation skyrocketed.

In response, the Bank of England (BoE) increased its “base rate” and banks and building societies responded by increasing their own cash savings interest rates.

As inflation has returned to the target of 2%, the BoE cut the base rate from 5.25% to 5% on 1 August 2024, with interest rates expected to continue falling in the future. Despite this recent cut, cash savings interest rates have risen considerably in recent years and currently remain high.

For instance, Moneyfacts reports that the average easy-access savings account interest rate was 0.17% in September 2021.

If you were a higher-rate taxpayer with £50,000 in a savings account with an interest rate of 0.17%, you would earn £85 a year in interest. This would be within your PSA and, consequently, you wouldn’t usually pay tax on the interest.

Yet, more recent figures from Moneyfacts reveal that the best interest rate on an easy access savings account on 7 August 2024 was 5.2%. If you had the same £50,000 in this account, you’d earn £2,600 a year in interest. After applying your PSA of £500, you’d likely be liable for tax on the remaining £2,100.

As a higher-rate taxpayer this means you could pay £840 in tax on your cash savings interest. If you’re an additional-rate taxpayer, you may be liable for tax of £1,170.

You could be affected by “fiscal drag” in the future

The term “fiscal drag” describes a situation where more of your wealth may be liable for tax without tax rates actually increasing. For example, frozen tax thresholds may mean more of your income exceeds the threshold and you pay more tax, or you pay a higher rate of tax on more of your earnings.

Indeed, according to Professional Adviser, since 2021/22, the number of higher-rate taxpayers has increased by 42% and there are more than twice as many additional-rate taxpayers.

If you’re affected by fiscal drag and move into a higher tax band, this means that you’ll benefit from a lower PSA and potentially pay tax on more of your savings interest. Additionally, you could pay a higher tax rate on your savings interest if your marginal rate of Income Tax increases.

This combination of higher interest rates and fiscal drag could mean that you pay a significant amount of tax on your cash savings interest. Fortunately, there are ways to mitigate this.

3 ways to reduce the tax you pay on cash savings interest

1. Use your full ISA allowance

You don’t pay Income Tax, Dividend Tax, or Capital Gains Tax (CGT) on the interest or returns you generate in an ISA. As a result, any interest you build on savings in a Cash ISA won’t count towards your PSA.

In the 2024/25 tax year, you can contribute up to £20,000 across all your ISAs. You may want to use as much of this allowance as possible before you save elsewhere so you can reduce the tax you pay.

Additionally, everybody has their own individual ISA allowance. As such, your spouse, civil partner, or partner could also use their full allowance, meaning you could collectively save £40,000 a year without paying tax on your interest.

You can also pay up to £9,000 a year into a Junior ISA (JISA) for a child, and this is separate from your own ISA allowance.

Consequently, if you and your partner have both used your full ISA allowances, you might benefit from contributing to a JISA to build wealth for your children or grandchildren and mitigate a large tax bill at the same time.

2. Increase your pension contributions

If you have already maximised your ISA allowance, you may then consider saving in a non-ISA account, but this could mean you are liable for tax on your returns.

If you’re looking to use your surplus funds to build up your retirement pot, you might decide instead to increase your pension contributions. You’ll benefit from tax relief at your marginal rate and, as your savings are invested, they could grow over time.

This might mean you see higher returns than you would if you put the same amount of wealth into a cash savings account, and any growth is within a tax-efficient wrapper.

However, you won’t be able to access the funds until you’re 55 (rising to 57 in 2028). As a result, this option may only be suitable if you already have enough in cash savings to act as an emergency fund and meet short- to medium-term goals.

3. Consider tax-efficient savings alternatives

In some cases, you may benefit from tax-efficient savings alternatives such as Premium Bonds. Every £1 you hold in Premium Bonds gives you one entry into a monthly prize draw with the chance of winning up to £1 million. Any prize you win is paid tax-free, so holding Premium Bonds could generate some tax-efficient returns.

However, you may win small prizes or nothing at all. So, you might not see reliable returns from Premium Bonds – although they are secure and you can withdraw your funds with no notice.

You may benefit from professional advice as we can help you determine which savings vehicles are most suited to your unique financial goals.

Get in touch

If you want to explore the most tax-efficient ways to hold your wealth, we can help.

Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

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.