Interest rate rise warning as up to 2m now set to pay tax on their savings – how to avoid

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 2024/25 year will be 2.1 million, up from around 650,000 just three years ago in 2021/22, according to figures obtained from a Freedom of Information request by stockbrokers AJ Bell.

In March 2025 - the end of the financial year - the Bank of England's base rate was 4.5%, down from a high of 5.25% which lasted until August 2024.

These high interest rates are generally passed on to savers, giving a boost to their accounts after years of rock-bottom returns. But this higher return also means more are likely to exceed the Personal Savings Allowance, especially because it hasn't changed since it was introduced eight years ago.

The amount of tax paid is also exacerbated because income tax bands have been frozen since April 2021 despite rising wages, pushing more people into the higher and additional rate bands which not only raises the percentage of tax they have to pay on interest made, it also lowers their Personal Savings Allowance. So it's a triple whammy for savers.

According to NimbleFins’ Best Savings Accounts Guide, Birmingham Bank is offering 4.67% interest on a one-year fixed rate account, while Principality is offering 7.5% for its regular saver.

The number of basic-rate taxpayers being hit with the tax will near 1 million people this year, up from just half a million in the 2022/23 tax year according to AJ Bell.

It estimated 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.

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.

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.

In fact, a record £11.7 billion was put into cash ISAs in April 2024 - the highest since they were introduced in 1999.

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).

Billions left in zero-interest accounts

While many savers are being forced to pay more tax, some are not taking advantage of higher interest rates, with £276bn of savings earning no interest at all.

Laura Suter, director of personal finance at AJ Bell, said: "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.

"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."

Read more on the bank accounts you could switch to here: £276bn of savings earning zero interest - best accounts to switch to today

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