Interest rates on savings accounts have risen throughout this year, with some banks currently offering more than 6%.
This has been good news for savers but, unfortunately, there’s a catch.
Higher interest rates mean everyone is earning a lot more money in interest, and more interest could mean paying tax on those earnings.
Currently, basic rate taxpayers can earn £1,000 a year in interest before any tax is owed, while higher rate taxpayers can earn £500 before paying HMRC any of it.
With interest rates below 1% for more than a decade, this wasn’t an issue for many people, but now the PSA is looming large.
In a recent report from AJ Bell, it is estimated more than 2.7million people will owe tax on cash interest in the 2023-24 tax year. This total includes nearly 1.4million basic-rate taxpayers, a number that has quadruped in four years.
This means more and more people will be faced with a tax bill they might not be expecting to pay.
Laura Suter, head of personal finance at AJ Bell, commented: “These figures highlight just how many taxpayers are facing a tax bill for their savings interest this year – a huge leap when compared to last year.
“Rising rates and a frozen personal savings allowance means some individuals are being taxed despite having relatively modest pots of cash set aside for a rainy day.”
This might be worrying news to many, but let’s look at what actually happens if you have exceeded the PSA.
Firstly, paying tax on your savings interest works slightly differently depending on how you work.
If you are self-employed, fill in your self-assessment as normal and declare the interest on your savings. You’ll then find out how much tax is due.
However, if you are employed and taxed under PAYE, things are slightly different.
HMRC told money.co.uk: “If you’re employed or get a pension, HMRC will change your tax code so you pay the tax automatically.
“To decide your tax code, HMRC will estimate how much interest you’ll get in the current year by looking at how much you got the previous year.
“Therefore, if a customer earns interest above their personal savings allowance and is employed or receives a pension, in many cases, we will automatically update their tax code with the information we receive and collect any tax due.
“Plus, customers need to register for Self Assessment (SA) if their income from savings and investments is more than £10,000.
"If their income from savings and investments is less than that, as will be the case for the overwhelming majority, then they don’t need to register for SA purely to declare income from these sources. Customers should check if they need to send a tax return if they’re not sure.”
It’s important to note, the PSA also applies to other types of savings income, not just the interest you’ve earned on bank accounts.
For example, income from corporate bonds and gifts, plus interest from providers like credit unions and NS&I products. The full list can be found on the government website.
However, if you want to avoid paying tax on your savings interest, you can always move your savings into an ISA. Everyone has an ISA allowance of £20,000 a year, which means you can move some of your savings into an ISA and earn interest tax-free.
There are different types of ISAs, and you can split your allowance between accounts - ranging from a flexible cash ISA to a lifetime ISA, which encourages people to save for their first home or retirement.
Shawbrook Bank is currently offering an easy access cash ISA at 4.43% and it has a one-year fixed-rate bond at a competitive interest rate of 5.78%.
Alternatively, you can look closer to home and split your savings with a spouse, if they haven’t used up their PSA or are on a lower income tax band than you.
The key with paying tax on your savings is to not bury your head in the sand and face the reality that you might lose some of the interest you’ve earned.
Remember to keep an eye on your payslip if you are employed or keep a note of your savings so you can fill in your self assessment accurately.
Plus, HMRC is also always on hand to answer any questions, if you have any specific concerns.
As a trained journalist, Lucinda has spent the past 10 years writing and editing content for regional and national titles, including The Mirror, WalesOnline and Manchester Evening News. She is now a personal finance editor and specialises in savings, helping people to make confident financial decisions so they can save for what matters most.