By Clare Yates
6 min read
When it comes to savings, most of us focus on how much interest we’ll earn and forget about tax. Thankfully, there are clear rules that make it fairly straightforward, especially if your savings are modest. Understanding your allowances can help you plan your savings better and avoid surprises at tax time.
How much savings interest can you earn tax-free?
Most people can earn some interest from their savings without paying tax. Your allowances for earning interest before you have to pay tax include:
Personal Allowance.
Starting rate for savings.
Personal Savings Allowance.
You get these allowances each tax year (6 April to 5 April), and how much you get depends on your other income. Understanding these rules helps you make the most of your savings and can even save you from having to fill in a tax return unnecessarily.
Personal Allowance
Your Personal Allowance is the amount of income you can earn each year without paying income tax. Currently, the Personal Allowance is £12,570.
It covers wages, pensions, or other income you receive, and savings interest counts on top of that. For most people, this means that if your total income, including interest, stays under the allowance, you won’t pay any tax at all.
Starting rate for savings
If your income is quite low, you might also qualify for something called the “starting rate for savings”.
Up to £5,000 interest: If your other income (like wages or pension) is under £17,570, you could get up to £5,000 of your savings interest tax-free.
Tapered system: The more you earn from other income, the less of this allowance you’ll get. Once you earn £17,570 or more (not including savings interest), the starting rate disappears altogether.
This means some people on lower incomes can actually have thousands of pounds in savings interest and still not pay tax on it.
Personal Savings Allowance
Here’s the part that makes most people breathe a sigh of relief – the Personal Savings Allowance (PSA) This allowance lets you earn a certain amount of savings interest each tax year without paying any tax on it:
Basic rate taxpayers (20%): You can earn up to £1,000 in savings interest tax-free.
Higher rate taxpayers (40%): You can earn up to £500 in savings tax-free.
Additional rate taxpayers (45%): Sorry, you don’t get a PSA.
For many people, this allowance is enough to cover all the interest they make. But with higher rates around in recent years, some savers may be finding themselves edging closer to the limit.
It also applies automatically, so you usually don’t need to do anything to claim it; the bank or HMRC typically handles the calculations through your tax code (read more on this further down).
What interest is covered by the Personal Savings Allowance?
The PSA applies to interest from a number of sources of savings and investment interest:
Bank and building society accounts.
Savings and credit union accounts.
Unit trusts, investment trusts and open-ended investment companies.
Peer-to-peer lending.
Trust funds.
Payment protection insurance (PPI).
Government or company bonds.
Life annuity payments.
Some life insurance contracts.
Money in tax-free accounts like Individual Savings Accounts (ISAs) and certain National Savings & Investments products are already covered as tax-free savings, so they won’t eat into your allowance.
How having just £3,500 in savings can take you over your allowance
If you pay the higher 40% rate of tax, your Personal Savings Allowance is just £500. That means it doesn’t take much to tip you over the limit. In fact, even putting away as little as £3,500 in a three-year fixed-term savings account could do it.
Here’s why: fixed accounts pay out all the interest in one go, rather than spreading it over the years you’ve locked your money away. So if you put £3,500 into a three-year fixed account paying 5%, you’d earn just over £500 in interest – but it would all be paid out in a single tax year at the end of the term.
That one-off lump sum of interest would push you over your £500 Personal Savings Allowance, even before adding in any other savings interest you might have. And if that happens, you can expect a tax warning letter from HMRC.
How do I pay tax on savings interest?
How you’re taxed on savings interest depends on how you usually pay tax:
If you’re employed or receiving a pension: HMRC will usually adjust your tax code so any tax owed on savings interest is collected automatically from your income.
If you earn more than £10,000 from savings: You’ll need to report it through a Self Assessment tax return.
If you complete self-assessment returns: Any savings interest can be included as part of your usual tax return.
If none of the above apply: HMRC will contact you if you owe tax on savings interest.
The key point is that tax on savings interest is mostly handled automatically, and you only need to take further action if your interest is substantial or you normally complete a Self Assessment return.
To help you stay on top of the tax you owe, HMRC may issue you a tax warning letter if it believes you may have earned more in savings interest than your allowances cover. Read more about his topic in our guide: What are HMRC tax warning letters to savers?
Paying tax on interest from joint accounts
For joint savings accounts, the interest is normally divided equally between all account holders. If you believe it should be shared in a different way, you’ll need to let HM Revenue and Customs (HMRC) know.
Tax on savings interest is usually straightforward
We’ve ended on the good news that you don’t usually need to report your savings interest yourself, as your bank or building society sends this information straight to HMRC.
However, it’s still important to keep track of the interest you earn across all your accounts. This way you’ll know if you’re within your Personal Savings Allowance, and you’ll have accurate figures ready if you ever need to include them on a Self Assessment tax return.
Want to check if you owe any tax on your savings? HMRC has an online tool to help some savers calculate the tax due on interest from savings.