After years of record low interest rates in the UK, the Bank of England (BoE) raised the base rate 14 times in a row between December 2021 and August 2023, when it reached 5.25%.

While higher interest rates make it more expensive to borrow money – you may have seen your mortgage repayments increase, for example – you might also have experienced a welcome boost to the amount of interest you earn on your savings.

However, any cash savings that aren’t held in a tax-efficient wrapper could be liable for Income Tax if they exceed your Personal Savings Allowance (PSA). Indeed, This is Money has revealed that HMRC is set to receive £10.4 billion in tax on savings interest in 2024/25.

Interest rates are expected to fall by the end of the year, but these changes are likely to come gradually. So, read on to learn more about paying tax on savings interest and discover three practical tips for mitigating a potential tax bill.

You can earn tax-free interest up to your Personal Savings Allowance

If you’re a basic- or higher-rate taxpayer, you’re entitled to earn a certain amount of interest from non-ISA savings without paying tax. This is your Personal Savings Allowance (PSA). 

The table below shows the PSA for each tax band.

Income Tax band	Personal Savings Allowance (PSA)
Basic rate	£1,000
Higher rate	£500
Additional rate	£0

You’ll usually pay tax at your marginal rate of Income Tax on any interest that exceeds your PSA.

Higher interest rates and frozen tax thresholds could increase the tax you pay on savings interest

Despite the recent base rate cut from 5.25% to 5% on 1 August 2024, cash savings interest rates have risen sharply and remain considerably higher than they were several years ago.

In early December 2021, the top easy access account available was paying 0.75% whereas, according to Moneyfacts, the top rate available on 4 September 2024 was 5.2%.

Higher interest rates combined with the fact that the PSA has remained frozen at the initial levels set in 2016 mean that it’s currently much easier to exceed your PSA than it was previously.

For example, if you are a higher-rate taxpayer with £50,000 in a savings account offering an interest rate of 5.2% (the current top rate available for an easy access account), you would earn £2,600 a year in interest. As such, you would likely incur Income Tax on the £2,100 that falls beyond your £500 PSA.

In contrast, if you had the same £50,000 in a savings account when interest rates were as low as 0.75% (in December 2021), you would have made just £375 a year in interest. This would have been within your PSA, so you likely wouldn’t have paid tax on this interest.

What’s more, the government has frozen Income Tax thresholds at their 2021/22 levels until 2028. As a result, more of your income might exceed the threshold and you could potentially be dragged into a higher Income Tax bracket. Indeed, the Guardian has revealed that the number of UK higher-rate taxpayers increased to 6.31 million from just over 4.4 million between 2021/22 and 2024/25.

If you move into a higher tax bracket, you’re likely to see your PSA fall, making it even easier to exceed the limit and incur tax on savings interest.

3 clever ways to pay less tax on savings interest

• Save into an ISA

Every tax year you can save up to £20,000 (2024/25) into your ISAs tax-efficiently.

There are two main types of ISA. A Cash ISA works in much the same way as a savings account, but pays interest free from Income Tax. When you open a Stocks and Shares ISA, your money is typically invested in a range of asset classes including equities, and any returns you make are free of Income Tax, Dividend Tax, and Capital Gains Tax (CGT).

You could use your entire allowance by investing in a single ISA or split your £20,000 across multiple accounts. For example, you might choose to put £10,000 into a Cash ISA and £10,000 into a Stocks and Shares ISA.

Using your full annual ISA allowance could save you a significant amount in tax, compared to holding cash outside an ISA wrapper (where interest is liable for tax beyond your PSA, as described above). 

You could save even more tax-efficiently by planning your finances as a family. Everybody is entitled to an individual ISA allowance, so if you’ve used up yours, it might be beneficial to top up your spouse or partner’s account.

You can also pay up to £9,000 a year (2024/25) into a Junior ISA for a child under the age of 18 (this would not affect your personal ISA allowance).

• Invest in Premium Bonds

If you’ve used your full annual ISA allowance, you might want to consider investing in Premium Bonds as an additional tax-efficient savings option.

Premium Bonds don’t pay interest on your investment like a traditional savings account. Instead, every £1 bond you buy is entered into a monthly draw, giving you the chance to win up to £1 million. A key benefit is that all prizes are tax-free.

However, while Premium Bonds are considered a secure investment as they are backed by the government, there is no guarantee you’ll win anything. Indeed, according to NS&I, the odds of winning any prize (as of September 2024) are 21,000 to 1 for every £1 bond.

• Increase your pension contributions

Your pension is one of the most tax-efficient ways to save as you’ll normally benefit from tax relief at your marginal rate on contributions.

Remember that your Annual Allowance limits the amount of tax-efficient pension contributions you can make. In 2024/25, this stands at £60,000 or 100% of your earnings, whichever is lower. Your Annual Allowance may be lower if your income exceeds certain thresholds, or you have already flexibly accessed your pension.

What’s more, your pension savings could grow in a tax-efficient environment over time.

It is worth reviewing your current pension contributions and considering the tax benefits of increasing these to help you progress towards your long-term financial goals.

However, you won’t be able to access your pension funds until you’re 55 (rising to 57 in 2028). So, you might want to ensure you have sufficient savings to meet your short and medium-term needs before topping up your pension.

Get in touch

If you’d like to learn more about how to protect your savings from tax, we can help.

Please speak to your usual Dodd Wealthcare contact. Alternatively, please email info@doddwealthcare.co.uk or call 01228 530913 / 01768 864466.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.  

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. 

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

The Financial Conduct Authority does not regulate NS&I products.

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