It’s always a good idea to save money, whether you are accumulating an emergency fund, saving for a large purchase, or just putting some spare money away. Not many people know that savings can be taxed on interest. The more you have saved over £3,500, the more you need to know about the Personal Savings Allowance (PSA). This straightforward tax rule may be saving you money, or it could be catching you out if you are not paying attention.
We'll explain what the PSA is, who qualifies, and how much you can reasonably save before tax becomes an issue. We'll examine how to make your savings as tax-efficient as possible too.
What is the Personal Savings Allowance?
The Personal Savings Allowance is the amount of interest you can earn on your savings during the tax year and not pay tax on it. The allowance you get is based on what you earn and which income tax band you belong to.
This is how it is split:
If you're a basic rate taxpayer (with an income of no more than £37,700) you can earn up to £1,000 interest tax-free.
If you're a higher-rate taxpayer (you earn between £37,701 and £125,140), your tax-free allowance is reduced to £500.
If you're a higher-rate taxpayer (you earn over £125,140), you don't get any tax-free savings allowance.
This exemption is for interest on a broad range of sources, such as:
- Building society accounts and bank savings accounts
- Fixed-rate savings accounts
- Credit union accounts
- Government and corporate bonds
- Certain trust funds
It's also important to notice that the PSA doesn't cover dividend income from shares. That's addressed by a separate dividend allowance. It doesn't cover ISA interest either, because ISA savings are tax-free by definition.
How Much Can You Save Before Paying Tax?
One of the most frequently asked questions is how much can I save before being taxed on the interest. Although this varies based on the interest rate you receive, there are several useful estimates.
Based on MoneySavingExpert calculations, you'd need to have about £20,000 in an easy-access savings account paying a high rate to break the £1,000 PSA. That's assuming your interest rate is at about 5%, which some competitive savings accounts do pay at the moment.
If you're a higher-rate taxpayer with a £500 allowance, the limit is considerably lower. £10,000 or thereabouts set aside might be sufficient to tip you over the edge if you're earning a half-decent rate of interest.
For those with fixed-rate savings accounts, which tend to accrue even more interest, the scenario becomes ever more applicable. For instance, if you're a higher-rate taxpayer who has funds in a three-year fixed-rate account that's paying 5% interest, then it would take just £3,500 saved up over the duration to put you over your allowance. This is due to the fact that the interest is compounded and tends to be paid out in a single lump at the term's conclusion.
What Happens If You Go Over the Allowance?
If the interest you receive is more than your PSA, you'll have to pay tax on the amount above your allowance. This is normally deducted automatically as part of your PAYE tax code if you are an employee or in receipt of a pension. You can have next year's tax code adjusted to reclaim the tax owed.
If you fill in a Self Assessment tax return, you'll need to report the interest yourself and pay any tax owing as part of your yearly return.
This is the reason you have to monitor how much interest you are receiving. If you have savings in various accounts or spread out across multiple banks, it is simple to lose track and exceed the limit by accident.
How to Avoid Paying Tax on Your Savings Interest
If you're close to your PSA limit, or just wish to eliminate tax on savings entirely, one of the most effective ways is to utilise an ISA (Individual Savings Account).
A Cash ISA allows you to save up to £20,000 each tax year, and the interest is entirely tax-free no matter what your income. ISA savings do not depend on your tax band, making them a beneficial choice for individuals who have higher earnings and more savings.
There are other types of ISAs too, including:
- Shares and Stocks ISAs, which are appropriate for long-term investment
- Lifetime ISAs, which aim to assist you in saving for a first home or retirement
- Innovative Finance ISAs, e.g., peer-to-peer lending
You might also think about Premium Bonds, which are issued by National Savings and Investments (NS&I). You don't receive interest, but you're entered into monthly prize draws. Any winnings are free of tax, and you can put £50,000 into bonds.
Joint Accounts and Married Couples
If you hold a joint savings account with your partner or spouse, it is useful to know that the interest is generally divided 50/50 for tax. The two account holders can then both utilise their own PSA. You can receive up to £2,000 of interest tax-free between you if you are both within the basic rate band.
Married couples and civil partners will also gain from the Marriage Allowance, where one partner can transfer some of their personal tax allowance to the other. This will not directly impact your savings, but lower your overall tax bill.
Final Thoughts
Interest rates have been more favourable in recent years, which is good news for savers. But with the increased rates comes the increased likelihood of gaining interest that takes you over your Personal Savings Allowance. If you have more than £3,500 in savings, particularly in a fixed-term or high-interest account, now is the time to find out how the PSA affects you.
In conclusion:
- You can earn up to £1,000 interest without paying tax on it if you are a basic rate taxpayer.
- Higher-paid individuals have a lower allowance of £500.
- Taxpayers with higher tax rates do not get a tax-exempt allowance on savings interest.
Fixed-rate accounts can make it simpler to spend more than your allowance, despite modest savings. It could be tax-efficient to invest in a Cash ISA or to divide the savings among couples. By monitoring your interest and making use of the facilities available to you, you can make your savings work for you without paying more tax than necessary.