Do I have to pay tax on my savings?

Whether you have to pay tax on your savings depends on a range of factors – the type of savings account you have, interest rates, your income and whether you are a non, basic or higher rate taxpayer.

Interest rates – the give-and-take

Since early 2022, interest rates on savings accounts have rapidly increased. Some UK banks now offer over 6% per year. By contrast, in December 2021, most would offer less than 0.25%.

Higher interest rates mean greater income from savings, and savers can finally see their money working harder for them. However, higher interest rates are a double-edged sword, meaning you’re more likely to pay tax on your income.

What is my tax-free savings allowance?

How much you can earn tax-free on your savings depends on three inter-related factors:

• Your Personal Allowance. The standard Personal Allowance is £12,570 – the amount of income you can earn before you have to pay tax.  
• The starting rate for savings. You may be able to earn £5000 in interest and not pay tax on it. However, the more you earn from other income, such as your wages or pension, the less your starting rate for savings will be, or you may not be able to benefit from it at all.

• You reduce your starting rate for savings by £1 For every £1 of other income above your Personal Allowance.
• If your other income is £17,570 or more, you’re not eligible for the starting rate allowance, only your personal savings allowance.

• Your Personal Savings Allowance. If you’re a basic rate taxpayer (taxed at 20%), you can earn up to £1000 in interest and not pay tax on it. For higher-rate taxpayers (taxed at 40%), it’s £500. There is no allowance if you’re an additional rate tax payer (taxed at 45%).

Be aware that any savings income above your tax-free savings allowance will be taxed according to what tax bracket your combined savings interest and other earnings put you in.   For instance, Peter is a basic rate taxpayer earning £36,000 a year. If he invests £20,000 at 6%, he will earn £1,200 in annual savings income. His allowance as a basic rate taxpayer is £1,000. The excess £200 will be taxed at 20%, totalling £40.

Ways to reduce tax payments on savings

1. Open an Individual Savings Account (ISA). You can invest up to £20,000 a year. All income and growth generated are tax-free. ISA options include locked-in savings, easy-access accounts or stocks and shares investments. Be aware that interest rates are usually slightly lower in ISA accounts.
2. Invest money into a joint account with your partner. This way, you'll only be eligible to pay tax on half of the interest earned.
3. Invest money into your partner's name if they have unused allowances.
4. Make the most of your dividend allowance if you have investments that pay out dividends rather than interest. The first £1,000 in dividend income is tax-free.
5. Gift money to your children or grandchildren to keep you below the relevant allowance thresholds. You get an annual gifting allowance of £3,000 and an additional £3000 allowance if you didn’t use it the previous year. In some circumstances, you may still need to declare income on the interest.
6. Contribute more money to your pension. This may reduce your income from a higher tax to a basic tax threshold and this will increase your savings allowance from £500 to £1,000.

Do I need to do a tax return for my savings income?

Many years ago, UK banks would automatically deduct a certain percentage in tax from your savings income. This is no longer the case, and you must declare any income earned over your annual allowance. You can do this via a self-assessment tax return or simply by contacting HMRC. If you are currently employed and have to pay taxes on your savings, they may offer to adjust your income tax code to reflect your future income in and out of work.

If you want to discuss your own circumstances and how to make your savings work harder, get in touch for a no-obligation meeting.

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise.  You may get back less than the amount invested.

The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.