Warning for savers: As interest rates shoot up, more savers may become liable for tax

Even if you’ve a decent amount of savings, it’s possible you haven’t considered the possibility of paying tax on savings interest. After all, savings rates have been at rock-bottom levels for a number of years now, making it very difficult for most to exceed their Personal Savings Allowance.

Yet it’s likely many more savers will soon find themselves liable to pay tax on savings interest. Here’s everything you need to know.

What is the Personal Savings Allowance?

Introduced in 2016, the Personal Savings Allowance (PSA) refers to the amount of interest you can earn from a savings (or bank) account without having to pay tax.

For basic-rate taxpayers (20% tax rate), the PSA allows you to earn £1,000 in savings interest per year without having to notify the taxman. For higher-rate taxpayers (40%), it’s £500 per year. Meanwhile, additional-rate taxpayers (45%) don’t get an allowance.

Importantly, interest earned from any type of ISA is not covered under the PSA.

What is happening to savings rates?

Savings rates have been in the doldrums for the best part of a decade, with some accounts offering rates as low as 0.01%. Even market-leading deals over the past few years have been rather pitiful – with easy-access deals rarely exceeding 1%.

Yet, over the past few weeks, things have changed… BIG TIME. Right now, the top easy-access deal pays an impressive 2.25% AER variable. Meanwhile, the top fixed account pays 4.75% AER for three-years.

(Rates are changing fast, so see our best savings accounts guide for the current best buys).

Why are savings rates rising?

Savings rates are rising mainly because of the Bank of England has increased the cost of borrowing by hiking its base rate. The ‘base rate’ refers to the cost at which banks can lend to one another, and the BoE has increased it on SIX occasions already this year.

To put it in simple terms, when the base rate rises, savings rates usually become more generous. When the base rate goes down, the opposite happens.

The cost of borrowing has MASSIVELY increased in 2022

To put into context just how much the cost of borrowing has increased this year it's worth knowing that, in October 2021, the base rate sat at 0.1% — a 300-year low. In other words, banks could borrow for next to nothing just 12 months ago. Fast forward to today, however, and the base rate now stands at 2.25%.

Importantly, there are expectations the Bank of England will raise rates again when its Monetary Policy Committee next meets on 3 November. That’s because the Bank of England is under pressure to support the falling pound, and halt rising inflation. Even though inflation has dipped, it's far from under control.

Why will more savers be liable to pay tax on savings interest?

The reason why more people will soon be liable to pay tax on their savings is pretty simple. As savings rates rise, more and more savers are likely to find themselves earning interest that exceeds their PSA​.

For example, say you’re a basic-rate taxpayer and you had your cash in an easy-access account during October 2021.

A year ago, a market-leading easy-access account was paying in the region of 1% AER variable. This means that in order to exceed you PSA, you must have had roughly £100,000 saved in order to earn over £1,000 in interest.

Yet today, a basic-rate taxpayer saving in the top easy-access account can earn 2.25% AER variable. This means they would only need to have roughly £44,500 saved before exceeding their £1,000 annual limit. For higher-rate taxpayers, a little over £22,000 would do it.

If you do exceed your PSA, it’s worth knowing that the onus is on you to report your liability for tax to HMRC. HMRC will typically do this by changing your tax code.

To avoid having to pay tax, you may wish to consider putting some, or all, of your savings in a cash ISA instead. However, rates on cash ISA accounts are often far less generous than those offered on normal savings accounts — so do calculate whether the tax advantages are worth it.

Please note that tax treatment depends on your individual circumstances and may change in future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence.