Millions now face tax on their savings for first time in seven years

For the first time in almost seven years, savers have to pay tax on their savings interest.

Rising interest rates mean income from savings accounts could rise by hundreds of pounds this year.

This means millions of base rate taxpayers will be able to break their personal savings of £1,000 for the first time since its introduction in April 2016.

At the same time, the income tax thresholds have been frozen until April 2028. Those who receive a wage increase can therefore be dragged from the basic bracket of 20 percent to the higher rate of 40 percent.

As a result, their personal savings will be halved to £500 and any interest they earn above this level will be subject to tax.

Tax changes in this month’s budget are also expected to put some 232,000 taxpayers in the 45 percent tax bracket. They receive no compensation at all on their savings interest.

Base tax starts when your income reaches £12,571. You pay the higher 40 per cent rate once your income reaches £50,271 and the additional 45 per cent rate starts from April 2023 at £125,140. This was cut from £150,000 in the budget earlier this month.

The personal savings deduction gives around 27.2 million basic taxpayers the first £1,000 they earn tax-free each year in a regular savings account.

The 5.5 million higher rate taxpayers will receive a £500 allowance, while the 629,000 additional taxpayers will receive nothing.

The allowance has not been increased since its introduction. Laura Suter, head of personal finance at investment platform AJ Bell, says: “Income tax deductions have been frozen, so more people are being pushed to the next tax bracket and seeing their personal savings deduction reduced or gone altogether.”

Part of the reason why more people are at risk of paying tax is that the amount invested in taxable savings accounts has since risen massively – by 47 per cent to £1,167 trillion.

Due to years of low interest rates, savers have had little chance to use their tax-free capital. But with better rates and more savings, that’s about to change.

Sarah Coles, a personal finance analyst at investment platform Hargreaves Lansdown, says: “With interest rates higher, there’s an increasing chance of going over fee if you put more money on deposit.”

Last year, the best easy-to-access bill paid about 0.5 percent. As a base rate taxpayer, you could have £200,000 in your account and not earn enough interest to breach the personal savings deduction. For higher payers, the amount was £100,000.

Now, with the best rate at 2.81 per cent, the amounts have fallen to about a sixth of these levels, at £35,587 and £17,793 respectively.

The latest figures from HM Revenue and Customs show that in the year to April 2020, 13.9 million taxpayers received interest on their savings with banks and building societies.

What should savers do?

Look to use your Isa tax-free allowance. Once the darling of the savings world, cash Isas fell out of favor due to persistently low interest rates and the advent of personal savings.

ISAs work in the same way as a regular account, but all of your interest is automatically tax-free.

It also does not count towards your income when calculating the amount of income tax you must pay.

You can save £20,000 each tax year – that runs from April 6 one year to April 5 the next.

Top rates include 2.5 per cent from Scottish BS and Cynergy Bank in easily accessible accounts.

If you pay taxes, this is a better rate than earning a slightly higher 2.81 percent in a non-ISA account.

After a base tax of 20 percent, that works out to 2.24 percent or 1.68 percent for a higher payer.

The best one-year fixed rate Isa is 3.78 percent from Shawbrook Bank, while the best bond is 4.35 percent from Atom or GB Bank.

The latter will be worth 3.4 8 percent after tax to a base rate payer and 2.6 1 percent to someone paying a higher tax rate.

sy.morris@dailymail.co.uk

our best cash Isa savings tables