Tax on savings explained - how much will you pay?

Many savers with relatively modest sums in bank and building society accounts are likely to be caught up paying tax on savings as higher interest rates increase income. Find out how tax on savings interest works.

| 7 min read

The higher interest rates now available on cash stand in contrast to a prior decade of rock bottom returns. It’s welcome news for savers, but there’s a sting in the tail for many people – tax.

Interest on savings, outside of ISAs and over and above certain limits, is taxable and with interest rates having forged higher there are more and more savers being caught in the tax net.

That’s especially the case as bank and building society accounts now pay interest gross of basic rate tax by default rather than net of tax, which was the case before 6th April 2016.

The past year or so is the first time since the change that the Bank of England base rate has been above 1%, which implies many savers are unprepared for the tax liabilities the interest on their savings will shortly incur. Up to now they simply haven’t earned enough interest to worry about it.

It will have become a greater issue for the 2022/23 tax year, and even more so for the 2023/24 and 2024/25 tax years as interest rates have increased. Some cash savers are getting four or five times the interest they received a couple of years ago on the same sum.

How much tax do you pay on savings?

The tax rates on savings interest depend on how much earned income or other non-savings income you have, for example, rental income. If your taxable savings income falls within the basic rate band after these, and after the deduction of the income tax personal allowance if applicable (presently £12,570), you will normally pay income tax at the rate of 20%.

In the 2024/25 tax year, tax rates on income, including savings interest, are as follows:

  • The basic rate band is £37,700, which means broadly speaking you pay the 20% basic rate tax up to £50,270
  • If your taxable interest falls between £50,271 and £125,139, you would pay the higher rate of 40%
  • The additional rate of 45% is payable for savings interest above £125,140

Please note that tax rates on dividends from shares are different, and if you are a Scottish taxpayer the rates and bands are different too. Follow the link to find out more about the UK tax brackets.

But what about the tax-free allowance for savings interest?

The personal savings allowance introduced by the government in April 2016 means some people don’t pay tax on a limited amount of savings interest:

  • Basic rate taxpayers can earn £1,000 of interest in 2024/25 before paying tax
  • Higher rate taxpayers have a lower allowance of £500
  • Additional rate taxpayers don’t receive any personal savings allowance

There is also an extra ‘starting rate’ for savings, which is a special 0% rate of income tax for savings income of up to £5,000 for those with taxable income below £17,570 in 2024/25. You’ll only get the full starting rate amount if your other income is up to the personal allowance of £12,570.

Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.

Who pays tax on savings when interest rates are high?

Given the complexity of the rules outlined above, as well as the fact that the tax bands and allowances are now frozen for longer, many savers with relatively modest amounts in bank and building society accounts are likely to pay tax on savings as higher interest rates increase income.

By way of an example, you only need to have £20,000 in savings attracting an average rate of 5% to use up the personal savings allowance of £1,000 if you are a basic rate taxpayer. It’s another example of relentless ‘fiscal drag’, where higher inflation and earnings can cause more people to pay higher rates of tax.

Sums required to use up personal savings allowance for a basic rate taxpayer assuming different rates of interest

Interest rateSums required

Some people do not realise that if your income from savings and investments is over £100,000 you automatically need to register for Self Assessment. Others will have to arrange to pay tax on their savings that fall outside of the various allowances.

For many people this can be done automatically. If you’re employed or get a pension, HMRC will estimate how much interest you’ll get and change your tax code. If you’re not employed, do not get a pension or do not complete Self Assessment, your bank or building society will tell HMRC how much interest you received at the end of the year. HMRC will then tell you if you need to pay tax and how to pay it.

What else counts towards the personal savings allowance?

Individuals need to watch out as it is not just interest on savings that counts towards the personal savings allowance and, if applicable, the starting rate of savings. Income from certain investments do too including unit trusts and open-ended investment companies where income is classed as interest rather than dividends, government bonds (gilts), corporate bonds, purchased life annuities and some life insurance contracts. Add these to the equation and many unwitting investors are going to be potentially exceeding the modest savings allowance.

However, savings and interest-bearing investments in tax-free accounts like Individual Savings Accounts (ISAs) and some National Savings and Investments accounts do not count towards the allowance.

Keeping tabs on your savings

Fortunately, there are ways to not only keep a good handle on the interest you are paid on your cash, but also maximise the rates you receive. Charles Stanley Direct Cash Savings offers access to a range of the banks and building societies to help our clients get the best deals quickly and easily through one online account. Every tax year you receive a clear breakdown of the interest income earned during the tax year, facilitating accurate reporting to HMRC.

Choosing and switching cash accounts also couldn't be easier.

  • Manage your savings in one place, moving between highly competitive accounts with ease
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  • Provided in conjunction with Bondsmith, a financial technology company authorised by the Financial Conduct Authority

Find out more

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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Charles Stanley is not a tax adviser. Information contained within this page is based on our understanding of current HMRC legislation. Tax reliefs and allowances are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.