Savings interest is taxable in the UK, but most people don’t pay any tax thanks to the Personal Savings Allowance. Here’s how it works and how to keep more of your interest.
How Savings Tax Works
Savings interest is taxed after your Personal Allowance and other income. The order of taxation is:
- Personal Allowance (first £12,570 of total income)
- Non-savings income (employment, pension, rental)
- Savings income (interest, dividends)
- Dividend income
This means your savings interest only starts being taxed once you’ve used up your Personal Allowance on other income.
Personal Savings Allowance (PSA)
The PSA lets you earn a certain amount of interest tax-free each year, depending on your income tax rate:
| Income Tax Band | PSA Amount |
|---|---|
| Basic rate (20%) | £1,000 |
| Higher rate (40%) | £500 |
| Additional rate (45%) | £0 |
Your PSA is based on your total income, not just savings. If you’re a basic rate taxpayer, you can earn £1,000 in interest without paying any tax on it.
Example
- Salary: £30,000 (basic rate taxpayer)
- Savings: £20,000 at 5% interest = £1,000
- PSA covers the full £1,000
- Tax on savings: £0
Starting Rate for Savings
If your total income is low, you may get an additional savings allowance. The starting rate for savings gives you up to £5,000 of tax-free interest.
You qualify if your total income (excluding savings) is below £17,570. The starting rate reduces by £1 for every £1 of non-savings income above the Personal Allowance.
Example:
- Non-savings income: £14,000
- Personal Allowance: £12,570
- Non-savings income above PA: £1,430
- Starting rate for savings: £5,000 - £1,430 = £3,570
You’d also have your £1,000 PSA on top, giving you £4,570 of tax-free interest.
Tax-Free Savings Accounts
Some savings are completely exempt from tax:
Individual Savings Accounts (ISAs)
ISAs let you earn interest or investment returns tax-free. The annual allowance is £20,000 across all ISA types:
- Cash ISA - Earns interest tax-free
- Stocks & Shares ISA - Investments grow tax-free
- Lifetime ISA - For under-40s, 25% government bonus
- Innovative Finance ISA - Peer-to-peer lending tax-free
NS&I Premium Bonds
Premium Bonds are tax-free. Any winnings from the monthly prize draw are not subject to income tax or capital gains tax.
Other Tax-Free Savings
- Help to Save (for Universal Credit claimants)
- Child Trust Funds and Junior ISAs
- Interest on qualifying loans (Advanced Life Limited)
How to Reduce Your Savings Tax Bill
1. Use Your ISA Allowance
ISAs are the simplest way to shelter savings from tax. You can put up to £20,000 per tax year into ISAs.
Tip: If you have £20,000 in savings earning 5%, that’s £1,000 interest. In an ISA, it’s completely tax-free.
2. Maximise Your PSA
Make sure you’re not earning interest in accounts that don’t qualify for PSA. Most bank and building society accounts qualify, but some offshore accounts don’t.
3. Split Savings Between Spouses
If one partner uses their PSA and the other doesn’t, consider transferring savings to the lower earner. There’s no tax on transferring between spouses.
4. Use Premium Bonds
If you’ve maxed your ISA allowance, Premium Bonds offer tax-free returns (though average returns are lower than cash ISAs).
5. Consider Timing
If you’re likely to move into a higher tax band, consider using your ISA allowance before the end of the tax year.
Example: How Tax on Savings Works
Let’s say you have:
- Salary: £55,000 (higher rate taxpayer)
- Savings: £30,000 at 4.5% = £1,350 interest
Tax calculation:
- Your PSA: £500 (higher rate)
- Taxable interest: £1,350 - £500 = £850
- Tax at 40%: £340
If that same £30,000 was in a Cash ISA:
- Interest: £1,350
- Tax: £0
Key Takeaways
- Most people pay no tax on savings interest thanks to the PSA
- ISAs are the best way to shelter savings from tax
- Starting rate gives extra relief for low earners
- Split savings between spouses to use both PSAs
- Premium Bonds are completely tax-free
Check your savings interest against your PSA each year. If you’re close to the limit, consider moving excess savings to an ISA.