Two million to pay tax on cash savings interest

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 Government 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 the 2022/23 tax year.

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.

The total number of people with Income Tax liabilities on savings income

Source: HMRC/AJ Bell. The 2020-21 and 2021-22 figures are outturn based on the 2020-21 and 2021-22 Survey of Personal Incomes (SPI) respectively. The 2022-23, 2023-24 and 2024-25 estimates are based on the 2021-22 SPI.

What do the figures mean?

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 savings tax

1. Cash ISAs: Cash ISAs are an obvious port of call for those seeking to shelter their savings from tax. The downside of this approach has always been that you usually have to accept a slightly lower interest rate than on a standard savings account, but for many the implications of not sheltering your interest from tax probably now far outweigh the haircut you take on the headline return.
2. Premium bonds: Interest from premium bonds is also tax-free, though again the headline interest rate is usually below what you can get from other easy access accounts. The pooled interest is not shared equally either, so you may end up with more or less than the advertised rate. However that does open up the possibility of winning big on premium bonds, an appeal which no doubt partly fuels their popularity.
3. Stocks and shares ISAs: Stocks and shares ISAs are perhaps a surprising way of reducing your interest rate tax bill. That’s because you can invest in money market funds within these tax shelters. These funds invest in cash-like fixed interest securities issued by governments and companies, and though they are a bit riskier than cash, they do now come with generous yields thanks to rising interest rates. The interest paid on these funds is tax-free if held within a Stocks and shares ISA, but investors do need to factor in fund management and platform charges when comparing with other options.
4. Gilty pleasures: We’ve also seen investors using short-dated, low coupon gilts to minimise tax. Most of the quoted yield from these investments comes from an appreciation of the price of the gilt between now and maturity, rather than from interest payments. Gilts aren’t subject to capital gains tax, so some investors have been turning to these instruments instead of cash to minimise the tax they pay. There are costs and charges associated with buying gilts, and they can be difficult to understand, so this route is probably best left to experienced investors, or those who are willing to roll up their sleeves and do their homework on how gilts work.
5. Buddy up: Sharing out cash assets smartly between spouses or civil partners can be a good way to reduce your tax bill as a couple. To increase tax efficiency you might consider sharing out savings to make sure each of you is using your Personal Savings Allowance to the max, and beyond that trying to move more interest-bearing cash into the name of the partner in the lower tax bracket, where there is a difference. While the sharing of cash assets might be desirable from an income tax point of view, there may be other considerations to take into account, such as the background context of other family finances, the convenience of joint accounts, wills and potential IHT liabilities.
6. Smart fixing: Savers can also use fixed term savings accounts to mitigate their tax affairs. This is because some fixed term accounts only pay out at the end of the term, and so you can defer the receipt of your interest, and hence the tax. This might be particularly useful if you know you are going to drop down a tax band next year, perhaps because you’re retiring, and therefore the interest you receive later rather than sooner will be taxed less heavily. Some fixed term accounts pay out interest more regularly though, so as ever, it pays to be on your toes.