How does savings interest and tax work?

Fact Checked

Explore how interest works on your savings and how tax can affect what you get as a return.

Share this guide
Young couple working out finances

Make the most of your tax-free ISA allowance.

Interest is paid on savings accounts as an incentive to place your money with a financial service provider, such as a bank or a building society. The interest rate paid depends on several factors, including the Bank of England base rate, which has been at historic lows for over a decade. 

However, as the base rate is expected to rise in the near future, savers could see the interest rate they earn also go up, making now a good time to consider opening a savings account.

What is savings interest?

Interest is money you earn in return for giving a bank or building society access to your money via a savings account. The amount of interest you earn is set by your savings account provider.

For example, if you have £1,000 in a 1 year fixed bond paying at rate of 2%, the savings interest you earn will be £20 over the year (2% of £1,000 = £20).

There are many things that affect the amount of interest your savings account will pay, such as:

  • The level of access you have

  • How often interest is paid out

  • How much you can pay in

  • Competition in the marketplace

  • If it’s taxable

What types of interest are there?

  • Compound interest: This is when you earn interest on the interest you have already received from your savings. You lose this if your interest is paid into another account

  • Annual interest: This is when your interest is paid once a year; either on a set date or on the maturity date of the account

  • Monthly interest: This is when you have your interest paid on a monthly basis. This method may work well if you want to receive your savings interest as a regular source of income

This table shows the difference between the interest you would earn on £5,000 over five years if you chose to compound interest or have your interest paid to another account:

Updated 20 April 2023
TimescaleCompound interest paid annuallyInterest paid out annuallyInterest difference
After 1 year£150£150£0
After 2 years£154.50£150£4.50
After 3 years£159.14£150£9.14
After 4 years£163.19£150£13.91
After 5 years£186.83£150£18.83
Total interest paid£813.66£750£46.37

When you get paid your interest monthly, your annual interest will be the same each year as long as the interest rate remains the same. Based on the table above, if you had your interest paid monthly you would have £12.50 paid to you each month.

Do you pay tax on savings?

You may be subject to tax, but you won’t need to pay tax on all of the interest you make on your savings if you qualify for one of the following: 

  • A starting rate for savings

  • A personal savings allowance

  • A personal allowance

  • Interest earnt from savings in an ISA

What is the starting rate for savings?

If you earn under £17,570 in other (non-interest) income, you will qualify for a starting rate for savings. This provides an initial buffer before you begin to eat into your personal savings allowance. It is currently set at £5,000 for the 2021/22 tax year.

You aren’t eligible for the starting rate of savings if your other annual income is £17,570 or more.

What is the personal savings allowance?

It is an allowance that lets you earn a set amount of interest from your savings without paying any tax.

  • Basic rate taxpayers can earn £1,000 worth of interest before paying tax on their savings

  • Higher rate taxpayers can earn £500 worth of interest before paying tax on their savings

  • Additional rate taxpayers will not have a personal savings allowance

The personal savings allowance is in addition to any other allowances that you may be entitled to. For the full list of personal savings allowance bands throughout the UK see the government advice page on tax rates and bands.

What is the personal allowance?

In addition to the starting rate for savings you may also qualify for a personal allowance. This lets you earn a set amount of money each tax year before you have to pay tax on your earnings, including your savings interest.

In the 2021/22 tax year, you have a personal allowance that lets you earn up to £12,570 without paying any tax. For every £1 you earn from other income over the personal allowance, your starting rate for savings decreases by £1.This means that you will only pay tax on savings interest if it exceeds your starting rate for savings and personal savings allowance and your total income exceeds your personal allowance.

This table shows you how much tax you pay on your taxable interest: Note that this table does not relate to Scotland, which has different rates.

Updated 20 April 2023
TaxpayerTax deductionTaxable income
Basic rate20%£12,571 to £50,270
Higher rate40%£50,271 to £150,000
Additional rate45%More than £150,000

Alternatively, you can earn interest tax free by using your ISA allowance each tax year. Here is everything you need to know about saving with an ISA.

How else can you save on savings tax?

You can also pay less tax if you qualify for one of the following:

Marriage Allowance

This lets you transfer up to £1,260 of your personal allowance to your husband, wife or civil partner. This could reduce their tax liability by up to £252 (for the 2021/22 tax year).

The transferring partner must normally have an annual income of £12,570 or less and the receiving partner must be a basic rate taxpayer.

Married Couple's Allowance

This could reduce your tax bill by between £353 and £912.50 a year if either you or your partner was born before 6th April 1935.

Visit the website to find out if you qualify for the Married Couple's Allowance.

Blind Persons Allowance

This is a £2,520 tax free allowance on top of your personal allowance.

You can transfer this allowance to your spouse or civil partner if you do not earn enough of an income to benefit from the full allowance.

To qualify for the Blind Person's Allowance, you need to be registered with your local council as blind or severely sight impaired.

Can you claim tax back?

If you have already paid tax on your savings this tax year you can ask your provider to refund after registering your R85 with them.

If you had paid tax in previous tax years you will need to complete an R40 form. This form allows HMRC to find out if you have overpaid tax and if you are owed a refund.

Maximise the value of your savings by hunting down the best rates available

About Dom James

View Dom James's full biography here or visit the press centre for our latest news.