Interest rate rise warning as up to 1.7m now set to pay tax on their savings – how to avoid

More than 1.7 million people were told to pay tax on their savings last year, with scores more expected to be hit this year due to soaring interest rates.

Anyone making more than £1,000 on their savings has to pay income tax on proceeds, with the threshold lowering the higher up the income tax bands you are.

The number paying tax on their investments from the 2022-23 tax year shot up 82 percent to 1.7 million, compared to 972,000 the previous year.

Back in March 2023 – the end of the last financial year - the Bank of England's base rate was 4.25%. It has since risen even higher to 5% meaning the amount of interest made on savings is also likely to rocket for many.

According to NimbleFins’ Best Savings Accounts Guide, First Save is offering 6.1% interest on a one-year fixed rate account, while Skipton Building Society is offering 7.5% for its regular saver.

The average saver had to pay almost £2,000 in tax on money made from their savings at the end of the last tax year, according to a Freedom of Information request to HMRC, made by stockbroker AJ Bell.

They expect this to rise to £2,500 this year, This is Money reports.

How tax on savings interest works

Each person can make a certain amount of profit from their savings before they start paying tax.

After they pass the threshold they will have to pay income tax on it, based on their income tax band.

For those who complete self-assessment forms, savings interest must be declared there. A self-assessment is mandatory for anyone making more than £10,000 from their savings.

Income Tax bandTax-free savings interestTax payable over threshold
Basic rate£1,00020%
Higher rate£50040%
Additional rate£045%

This does not apply to interest made on ISAs, which are tax-free.

There is also a higher allowance of up to £5,000 available for people who earn less than £17,570. The full £5,000 allowance is available to anyone who earns no more than the £12,570 personal allowance, and lowers by £1 for every £1 earned over the personal allowance. For more information on the so-called 'starting rate for savings', click here.

If tax is not declared, HMRC will get in touch about how to pay it using details from banks - which inform HMRC how much interest they paid.

How to avoid tax penalties on savings

There are a few ways to save money while lowering your tax burden.

1. Buy Premium Bonds

Because Premium Bonds don't pay interest, tax isn't charged (on savings up to £50,000).

Instead, the NS&I bonds offer the chance for investors to win up to £1 million every month.

As NimbleFins previously reported, the chance of winning a Premium Bonds prize has risen to the highest rate in 15 years.

Each £1 bond is entered into a draw every month, with prizes starting at £25 – and you don’t have to pay interest on any winnings.

However, unlike standard savings accounts with a guaranteed interest payment every year, there is no promise of making any money.

2. Invest in ISAs

ISA savers can invest up to £20,000 a year and don't need to pay tax on any interest in the account.

Stocks and shares ISAs could be a useful option if wanting to look at trading without the risk of having to pay interest, particularly as the capital gains tax threshold has been slashed from £12,300 to £6,000 since April. It is dropping further to £3,000 in 2024.

Outside of ISAs, you pay capital gains tax when you sell shares for a profit.

The dividend allowance is also dropping to £500 from April 2024, having already fallen from £2,000 to £1,000 in April 2023.

3. Top up your pension

You can pay up to 100% of your salary up to a maximum of £40,000 into a pension without having to pay tax every year.

Any capital gains made on your pension is tax-free, and you also earn tax relief on anything put away.

Ordinarily, HMRC would charge you income tax on money earned, but because that money is protected from tax, it's essentially cheaper to save.

Say you had £100 to save into your pension.

If you kept that as income, a basic rate taxpayer would only get £80 back (the other 20% goes to the taxman).

A higher rate taxpayer would only get £60 (40% would be paid to the taxman).

Those who took the money as income and then chose to save it would actually have less money to save.

But when putting that money into your pension, the whole £100 remains in tact and you get tax relief. So your £100 in savings savings only cost you £80 (or £60 for higher rate taxpayers).

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Helen Barnett

Helen is a journalist, editor and copywriter with 15 years' experience writing across print and digital publications. She previously edited the Daily Express website and has won awards as a reporter. Read more here.