Three years from now, millions of people will pay taxes on their cash savings, up from roughly 650,000
Ingenious strategies to hide your money from the tax collector are described.
A Freedom of Information (FOI) request to HMRC revealed that over two million savers will have to pay tax on their interest this tax year.
According to the taxman, the number of savers who will receive a tax bill has increased from 10.9 million in 2023 - 2024 to 20.7 million.
Three years ago, only 647,000 people were required to pay income tax on their cash savings in 2021 - 2022, which is a significant increase.
Interest rates rising over the past few years combined with frozen tax thresholds is the reason why more savers are being taxed, according to Laura Suter, director of personal finance at the investment platform AJ Bell, which requested the FOI.
HMRC estimates that the two million savers who will be billed this year are divided into approximately 954,000 basic-rate taxpayers, 590,000 higher-rate taxpayers, and 471,000 additional-rate taxpayers.
According to Suter, the number of basic-rate taxpayers who are now subject to savings tax has increased significantly, from just 500,000 in 2022 - 2023 to nearly one million today.
HMRC anticipates collecting an impressive 10p4 billion in savings interest taxes in 2024 - 2025.
Compared to just 1 point 4 billion three years ago and 9 point 1 billion last year (2023/2024), that represents an increase.
Suter remarks: "Many individuals may have accrued a substantial tax liability already this year due to their failure to recognize that they had exceeded their personal savings allowance (PSA)."
"Although it may be too late to address the issue for the current tax year, you can plan your savings and steer clear of some cunning tax pitfalls to prevent receiving an unexpected tax bill in 2025 - 2026.
We examine the PSA and savings tax, and we share some smart strategies to prevent the tax collector from stealing your hard-earned interest.
What is the savings tax mechanism?
Although savings income is taxed at your highest income tax rate, some of it may be exempt from taxes thanks to a number of exemptions. A portion of the 12,570 annual personal allowance may be available to those with little other income to earn interest tax-free.
Additionally, they might profit from the starting rate for savings, which starts at £5,000 and is deducted by one for each additional dollar of income over your personal allowance.
You no longer receive the starting rate for savings once your other income exceeds 17,570. However, basic-rate taxpayers are entitled to a personal savings allowance of £1,000 per year, which is tax-free for interest.
Additional-rate taxpayers receive no allowance, while higher-rate taxpayers see that drop to 500.
The fact that interest is taken into account when calculating your tax bracket is one somewhat counterintuitive aspect of the personal savings allowance.
Let's look at a saver who earned 500 in savings last year and 49,500 from salary. She paid basic-rate tax since her income was just below the 50,270 higher-rate tax bracket.
Suppose her interest increases to 1,500 this year. As a result, her personal savings allowance drops to £500 and her total income of £51,000 places her in the higher-rate band.
To what extent will taxes be applied to savings pots?
You might be shocked at how quickly you violate your PSA and must pay interest taxes if you have some savings stashed away that aren't in a cash ISA.
A tax-free personal savings allowance of £500 is available to higher-rate taxpayers. You would need a balance of 50,000 to earn £500 in interest annually if you were only earning 1% interest. But now that the base rate is at 4 percent, the majority of savers are making more than that. To earn 510 in interest annually and deplete their allowance, a person earning 3 percent on their cash would need to have a balance of 17,000 in their account.
What if you had a savings account that paid 6 percent? You would only need to deposit 8,400 to surpass your 500 allowance (since you would earn 504 over the course of the year). A higher-rate taxpayer who kept £20,000 in a 6 percent account would receive 1,200 in interest each year, but the tax bill would be 280 (700 x 40 percent tax).
Savers are being advised to consider not only the interest rate they receive on their savings but also the possible tax ramifications of the interest, as interest rates are still relatively high.
You can still get roughly 4 percent on easy-access accounts and 7 percent if you use regular saver accounts to their full potential.
Adam Thrower, Shawbrook Bank's head of savings, remarks, "For many years, tax on savings has been something of an aside due to low rates, but with high interest and frozen thresholds, this becomes more of a concern."
A major consideration for savers when determining where to invest their hard-earned money is taxation and the potential effects this may have on their overall returns.
Six ways to protect yourself from taxes.
1. Employ an ISA
A cash individual savings account (ISA) is the first choice, assuming you still wish to keep cash on hand rather than investing it or putting it into a pension.
Tax-free interest is available, and the top easy-access ISA currently offers more than 5.3 percent, and if you fix for a year, you can get roughly 4.5 percent. Look for cash ISAs that let you "transfer in" your old ISA, as this won't count towards your annual allowance, if you're opening a new one because the interest rate on your current one is garbage.
You can only contribute a maximum of 20,000 to all of your ISAs, including stocks and shares ISAs, in a given tax year. This is the current ISA allowance.
You might also search for a flexible ISA, which gives you the freedom to take money out and return it within the same tax year. This gives you more control over your savings and helps you pay for any unanticipated costs that may arise in life.
Suter remarks: "You should think about transferring some funds into an ISA if you have any ISA allowance left over from this tax year. Alternatively, you could divide the savings between you and your spouse in order to utilize both of your ISA benefits.
It may make sense to transfer any savings that are subject to taxes into your partner's name if they pay income tax at a lower rate. Just be sure that the savings interest doesn't cause them to fall into the next tax bracket and ruin all of your hard work.
2. Purchase premium bonds
National Savings and Investments Premium Bonds are an additional choice if your ISA limit of £20,000 has been reached and you still have extra money you need to hide from the tax man. Instead of paying interest, these offer tax-free monthly prizes worth between £25,000 and £1 million. The prize fund rate is intended to rival current interest rates.
The larger prizes that you are extremely unlikely to win skew the prize fund rate, which is currently 3 percent. With average luck, the average saver will receive a significantly lower rate of return. People who have very little are probably going to have nothing at all.
On the other hand, a person with average luck could anticipate winning about 1,900 annually with the maximum holding of £50,000. This implies that a 760 tax bill would have been avoided for someone who would have otherwise paid 40% tax on all of that income.
3. Make a larger mortgage payment
Over the past few months, mortgage rates have decreased slightly. According to data firm Moneyfacts, the average two-year fix is currently 5.33 percent, while the average five-year fix is 5.18 percent.
Many homeowners who are remortgaging after taking advantage of lower rates in recent years will still find these rates painful.
However, if you have extra money right now, especially savings that could be subject to taxes, it might be wise to pay off your mortgage in full. This will raise your home's equity and may result in a lower remortgage rate.
Another benefit of overpaying is that it lowers your interest payments and speeds up your path to mortgage freedom.
With the aid of our mortgage overpayment calculator, you can determine whether it's worthwhile to make overpayments by seeing how your monthly payments might change.
4. Make other bill payments
Instead of putting your money in savings and then discovering that the taxman is keeping a portion of the interest, it makes more sense to pay off any bills or debts that need to be paid off.
In addition to personal loans and credit cards, you might also have other bills to pay, such as your self-assessment tax return.
Typically, independent contractors pay their accounts twice a year, on January 31 and July 31. To pay for it, it makes sense to take money out of a taxable savings accountthat is, not your cash ISA or Premium Bonds.
5. Participate in a pension plan
Contributions to a pension are an additional choice if you're attempting to lower your savings and, consequently, your tax liability.
Aside from the fact that you receive tax breaks from the government, this has the advantage of increasing your retirement fund, which most of us aren't saving nearly enough for.
It's definitely worth checking if you have a workplace pension plan because you might discover that increasing your contributions also results in a larger contribution from your employer. This is free money.
An inexpensive self-invested personal pension (Sipp) is an alternative. Keep in mind that this option does entail locking your money away because pensions are not accessible until age 55 (it will rise to 57 in 2028).
Additionally, take note of the annual allowance, which is the highest amount you can contribute to all of your pension accounts in a single tax year. For 2024 - 2025, it is £60,000.
6. Think about different investments
Other tax-free saving options exist, but they require investing your money. Examples of tax-efficient investments include enterprise investment schemes (EISs), venture capital trusts (VCTs), and stocks and shares ISAs.
Before making an investment, consider your time horizon (the point at which you wish to access the funds), your risk tolerance, and whether investing is the right path for you.
When looking for ways to shelter their money, taxpayers with substantial savings and investments may need to consider options beyond their annual ISA allowance, according to Jackie Hall, a partner at the accounting firm RSM.
"For these individuals, it might be time to consider using an alternative wrapper to house savings and investments, such as an (offshore or onshore) investment bond or the use of a personal investment company (PIC)," she explains.
Bond investments typically increase in value without the holder being directly taxed. Rather, tax charges are postponed until the bond is cashed, though annual withdrawals of less than 5% are typically permitted without incurring any tax consequences.
If a company invests in a PIC wrapper, it will be subject to corporation tax on the underlying income and gains at a maximum rate of 25 percent, according to Hall. There may be substantial recurring savings because this is 20% lower than the top individual income tax rate of 45% (or 47% for Scottish taxpayers).
Nevertheless, a PIC might not be appropriate for short-term investment plans, she continues, because an individual will typically face an extra tax layer when they take money out of the PIC.
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