How to avoid paying tax on your savings
Nothing is worse than an unexpected tax bill. For thousands of savers, the rise in interest rates over the past couple of years means they are at risk of being charged on their returns – a problem few have had to worry about for years.
With savings rates now on the way down, learning how to protect your savings from tax has never been more important.
Here Telegraph Money explains how savings are taxed, how much you might pay and how you can avoid paying tax on your savings.
This guide will cover:
When do you pay tax on your savings?
You’ll pay tax on your savings if your money is not held in an Isa or other kind of tax-free or tax-exempt account (more on that below), and if the interest you earn exceeds your personal savings allowance.
This allowance depends on your income tax bracket, which is determined by how much income you receive. This could be from sources such as earnings from employment, rental income or money received from your state pension – as well as savings interest.
The returns you have made on your savings, known as interest, are calculated for the tax year which runs from April 6 to April 5.
How much interest on savings is tax-free?
Your tax-free savings allowance is determined by your income tax bracket – this is the highest rate of tax you pay on your income.
For basic-rate (20pc) taxpayers (who earn between £12,571–£50,270), the personal savings allowance is £1,000, reducing to £500 for those who pay higher-rate (40pc) tax (earning between £50,271–£125,140). If you’re an additional-rate (45pc) taxpayer (earning more than £125,140), then all savings interest is taxable.
To help provide some context, to make £1,000 in interest in one year, you would need to have £20,000 in a savings account with a 5pc interest rate.
How to increase your tax-free savings allowance
You could shield even more of your savings from tax if your annual income is below £17,571. That’s because those with a lower income are eligible for the “starting rate for savings”. This is up to £5,000 of tax-free savings interest.
Those who earn less than £12,570 (the personal allowance) get the full benefit, but it decreases pound for pound when you earn above and beyond the allowance.
Therefore, by the time you earn £17,571 all of the extra tax-free allowance will be used up.
The 0pc tax rate on savings interest is intended as a savings incentive for those on lower incomes, but it can benefit well-off households, too – as long as one spouse earns less than £17,570.
As the tax break is granted at an individual level, irrespective of the higher-earning spouse’s income, it means the couple can cut their prospective tax bills by transferring savings to the lower-earning spouse.
This could work for couples where, for example, one parent is working full-time while the other has a part-time job and looks after the children. Alternatively, among couples in later life, one spouse may have retired on a good occupational pension while the other spouse receives a lower pension.
In cases where one spouse earns, say, £12,000 and the other earns £50,000, as a couple they could potentially earn up to £7,000 in savings interest before paying tax, were they to use the full allowances available to them – as long as the lion’s share of savings were held by the spouse with a lower income.
Alternatively, you could look at options to reduce your income tax band. Ways to do this include increasing your pension contributions, giving money to charity and taking advantage of salary sacrifice schemes. Our guide to avoiding the 40pc tax bracket offers nine methods to consider.
How do you pay tax on savings?
How you pay tax on interest earned from your savings depends on how you usually pay tax. If you are employed or receive a pension, the process is simpler. HMRC will often change your PAYE tax code to take extra tax from your income.
This process is automatic for savings interest, but is slightly different if you earn dividend income when you will need to tell HMRC if you earn between £1,000 and £10,000.
If you earn more than £10,000 from your savings, you have to complete a self assessment tax return.
If you are self-employed and file by self-assessment anyway, you should report any savings or investment income as part of your tax return.
However if you are not employed, retired or complete a self-assessment tax return, your bank or building society will reach out on your behalf and notify HMRC how much interest you received that year. HMRC will then be in touch with you if you owe tax on these returns.
Note that even if your savings returns exceed your personal savings allowance, you may not pay tax if you have any remaining personal allowance you can offset. Income is taxed in a specific order; first non-savings income (earnings, pensions and rent) is taxed, then savings income (interest) and then dividends – payouts from companies to shareholders.
This means that unused personal allowance can be used to offset other forms of income. For instance, if you earn £12,000 a year, there is £570 available to offset against savings interest.
On the flip-side, income earned from your savings will be layered on top of other income you receive, and if you’re unfortunate, can push you into a higher tax bracket.
What are the tax-free savings options?
Of course, one of the best ways to protect your savings from tax is to put them in a tax-free savings account.
Isas
You can invest up to £20,000 into an Isa every year, and the returns you receive are tax-free. There are numerous different Isas to choose from, but you can only deposit up to £20,000 across all of them.
A cash Isa works like a normal savings account. You can choose between a fixed-rate cash Isa whereby the interest rate stays the same for the duration of the account term, or a variable rate which provides easy access to your money but the interest rate is liable to rise and fall.
Cash Isas have surged in popularity in recent years as interest rates have remained high since 2022.
Other savers opt to choose a stocks and shares Isa. Rather than earning interest, these savings are invested in the stock market and your money grows as the value of those assets increase. While this presents opportunities for greater returns, the value of your investments could also fall leaving you with less money than you paid in. Stocks and shares Isas are better suited to long-term savers who are comfortable riding out short-term performance dips.
Junior Isas and lifetime Isas operate slightly differently. You can save up to £9,000 each year into a junior Isa on behalf of a child under the age of 18. There are both cash and stocks and shares options.
Lifetime Isas, often referred to as a Lisa, allow savers to put in up to £4,000 per year, which the Government matches by 25pc. However, the money in a Lisa must be used to buy your first home or not withdrawn until you are 60. Breaking these rules comes with a severe withdrawal penalty, which will eat into your savings.
Pensions
Private pensions are taxed using an “exempt, exempt, taxed” model (EET). This means when you or your employer contributes to your pension, these contributions are exempt from tax.
Any pension growth thanks to the performance of your investments is also exempt from taxation. When you choose to withdraw from your pensions, these are taxed like other forms of income, however you are allowed to access up to 25pc of your pension as a tax-free lump sum.
There are limits set in place. Most workers can contribute up to £60,000 per year into their private pension, this is known as their annual pension allowance, but for high earners this amount is tapered.
It is reduced by £1 for every £2 earned over £260,000 and stops when the annual allowance reaches £10,000.
Labour had flirted with the idea of reintroducing the lifetime allowance as part of its election manifesto, a cap on the total amount of pension savings an individual could hold, set at £1,073,100, without incurring a tax charge. It was abolished on April 6 2024 and, despite rumours it would be reintroduced under a Labour government, Chancellor Rachel Reeves has so far dropped plans to reintroduce it.
Premium Bonds
Premium Bonds are Britain’s most popular savings product – arguably largely in part to the thrill of potentially winning a big cash prize, but also because these prizes are tax-free.
The Treasury-backed scheme – run by National Savings & Investments (NS&I) – was launched by the Government in 1957 to boost post-war savings.
Every month, each £1 bond number is entered into a prize draw, where there’s a chance to win millions of prizes with values between £25 and £1m.
Prizes are tax-free, and there are no penalties for cashing in bonds, meaning they operate a bit like an easy-access savings account.
However, winning a prize isn’t guaranteed, and your money won’t earn interest while it’s held by NS&I – for some, this means your money will lose value over time.
The odds of any Premium Bonds winning a prize in a monthly prize draw is one in 21,000.
Your chances of winning a prize depend on NS&I’s “prize fund rate” and the amount you’ve invested. You can hold between £25 and £50,000 of Premium Bonds meaning each person can have up to 50,000 numbers in the draw each month.
Savings tax FAQs
Where can I put my savings tax-free?
You can put your savings into an Isa which allows you to save up to £20,000 every year tax-free. More than 4,000 Britons are Isa millionaires, meaning they have built up saving pots of more than £1m. It took them an average of 22 years to get there.
You can also put £60,000 into your private pension every year tax-free so long as you earn less than £260,000 per year.
Other savers opt to use Premium Bonds. You can hold up to £50,000 of Premium Bonds, meaning you have 50,000 numbers that have the chance of being picked for a prize of up to £1m each month.
Do banks notify HMRC of savings interest?
If you pay tax on any savings interest over your allowance and you are employed or receive a pension, HMRC will change your tax codes so that the tax is paid automatically.
If you complete a self-assessment tax return, you should report any interest earned on savings there.
However if you are not employed, do not get a pension or do not complete self-assessment, your bank will usually notify HMRC how much interest you received. You will then be contacted by HMRC which will outline if you need to pay any tax and how to pay it.
Note that in the case of any untaxed income you receive, the onus is on you to declare it to HMRC, so it’s a good idea to keep up to date with how much savings interest you receive each tax year.
Do you pay tax on savings if you have retired?
If you have retired, you are still taxed on savings in all of the ways laid out in this article. You can take advantage of tax-free saving options, but the personal savings allowance still applies to you as it does to someone who is not retired.
