Call us: 01603 666132 -Office: 15 Palace Street, Norwich, Norfolk, NR3 1RT Download Our App

The cash savings interest tax trap - October 16th 2024

More people will have to pay tax on their savings interest this year due to increased interest rates coupled with a frozen tax-free savings limit. If you are in this position and do not complete annual tax returns, you need to notify HMRC of your liability to tax or you could face penalties.

A basic-rate taxpayer – with income up to £50,270 – can receive a total of £1,000 of savings interest before having to pay tax; for higher-rate taxpayers that limit is just £500. Additional-rate taxpayers – those with income over £125,140 – have to pay tax on all their interest.

If you complete a self-assessment tax return each year, you will already be declaring your savings income, so the tax will be collected alongside the tax on the rest of your income. Most employees do not complete tax returns so should check whether they have received more interest than their tax-free limit.

Declaring interest owed

Banks inform HMRC of all interest paid to savers, but it remains the responsibility of each person to declare any taxable income. You might find that HMRC automatically reduces your tax code to collect tax on interest received based on the information provided by banks. However, you could face an HMRC enquiry.

Until 2016, interest was normally paid to individuals with basic-rate tax deducted and only higher-rate taxpayers had more to pay. Since 2016, interest has been paid gross, but the personal savings allowance has protected many savers from having to worry about tax. However, that allowance has not risen in the eight years since its introduction.

Mitigation measures

There are ways to minimise your tax. Interest earned in a cash ISA (individual savings account) is free of tax and anyone aged 18 or over can put up to £20,000 a year into an ISA. Couples may be able to save tax by putting savings into the name of the lower earner rather than a joint savings account in which interest is taxed 50-50 between them.

If, to maximise your interest rate, you save into a longer-term, fixed-rate account, you may have the choice of rolling up all the interest until the end of the term or receiving it annually or monthly. If you receive all the interest on maturity, it will all be taxed in the one tax year, meaning more of it is likely to exceed your tax-free limit.