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3 effective methods for cutting tax on your cash savings interest

2.7 million people are expected to pay tax on their cash savings interest this year. Read about why you may be likely to pay, and how to reduce your bill.

21/09/2023
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Many people see cash savings as a “safe” option because you don’t assume the same level of risk that you might with investments. You can simply deposit the money and let it generate interest, and you often have easy access to the funds should you need them.

You may be especially inclined to put your wealth in a cash savings account right now as interest rates are rising, meaning you could see more growth than you have in recent years.

However, cash savings are not always as safe as they appear. If interest rates aren’t keeping pace with inflation, for example, your savings may lose their spending power over time.

It’s also important to consider that you may have to pay tax on the interest you generate, something that many people overlook. Unfortunately, the likelihood of a tax bill is growing.

Read on to learn why you may be more likely to pay tax on your cash savings interest in the future, and how you can potentially reduce the amount that you pay.

You may pay tax on interest that exceeds your Personal Savings Allowance

When you put your wealth in a savings account and start generating interest, it’s important to pay attention to your Personal Savings Allowance (PSA) – the amount of interest you can generate without paying tax on it.

Your PSA depends on your Income Tax band. In the 2023/2024 tax year, the PSA is:

• £1,000 for basic-rate taxpayers

• £500 for higher-rate taxpayers

• £0 for additional-rate taxpayers.

You’ll pay your marginal rate of Income Tax on any interest that exceeds this threshold. So, if you’re a higher- or additional-rate taxpayer, you may be more likely to exceed your PSA and pay 40% or 45% tax on your interest.

High inflation may already be affecting the purchasing power of your cash savings, so you probably don’t want to lose a portion of your interest to tax, too.

2.7 million people are expected to pay interest on their cash savings this year

As interest rates rise, you may become more likely to face tax on your interest.

According to FTAdviser [1], 2.7 million people are expected to pay tax on their cash savings interest this year, an increase of 1 million on the previous year.

This is partly because the PSA has not increased since its introduction in 2016, while the interest on cash savings accounts is rising rapidly.

For example, the best easy access savings account interest rate reported by Moneyfacts [2] on 1 September 2023 was 4.93%.

In comparison, Moneyfacts [3] also report that the average easy access savings account paid 0.2% interest in January 2022.

Interest rates are rising because the Bank of England [4] (BoE) increased its base rate again to 5.25% in August 2023 to combat rising inflation, and cash savings interest rates increased alongside it. While inflation remains above the government’s 2% target, interest rates could continue rising this year, too.

While this may see you receive more interest on your cash savings, it also means that you’re more likely to exceed the PSA.

For example, in January 2022 if you were a higher-rate taxpayer contributing to a savings account with the average interest rate of 0.2%, you would have been able to save £250,000 before paying any tax on the interest.

Yet now, you can only save £10,141 in the best easy access savings account on 1 September with a rate of 4.93% before you start paying tax on the interest.

As a result, you may face a tax bill, even if you only have a fairly small amount of your money in your cash savings account.

Fortunately, there are several ways that you can potentially reduce the tax you’ll face.

3 effective ways to reduce the tax on your cash savings interest

1. Use your full ISA allowance

Any interest that you generate from savings in a Cash ISA does not count towards your PSA and is free from Income Tax. So, it may be sensible to pay into a Cash ISA instead of a standard savings account.

You can contribute up to £20,000 across all your ISAs in the 2023/2024 tax year. Using as much of this allowance as possible may help you reduce your tax bill.

2. Consider increasing your pension contributions

While it may be useful to keep some cash savings as an emergency fund, holding more of your wealth in your pension could help you avoid paying tax on your savings interest.

You can receive tax relief at your marginal rate on pension contributions and there’s no Income Tax to pay on interest generated within your pension.

If you’ve exceeded the PSA, you could consider moving some of your savings into your pension instead. This may reduce the interest you generate in savings and bring you closer to or even below the PSA, so you do not pay as much tax.

Your employer may match your contributions and your funds will be invested by your pension provider, too. So, you may see more growth than you would from a cash savings account.

Bear in mind that there’s a limit on how much you can tax-efficiently contribute to your pension in a single tax year. Make sure to check that you haven’t exceeded this limit before you make additional contributions.

3. Share savings with your partner

Joint planning with your partner could help you both reduce the tax that you pay on cash savings interest. You each have your own separate PSA, so you may want to consider how you divide your savings between you.

For example, if you’re close to exceeding your PSA while your partner has a smaller amount in savings, it may be useful for them to hold more in their savings account instead, so both of you remain within your PSA.

This can also be helpful if one of you is in a lower tax bracket. For example, if you pay higher-rate Income Tax and your partner is a basic-rate taxpayer, they’ll have a larger PSA than you. They’ll also pay tax at a lower rate than you if they do ultimately exceed the PSA.

Get in touch

If you’re concerned about the tax you may pay on your cash savings interest, we can help you with methods to make your wealth as tax-efficient as possible.

Please visit our contact page or speak to your adviser.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

[1] 05.09.2023 Official Bank Rate history Bank of England

[2] 05.09.2023 Some 2.7mn Brits to be hit with tax on cash savings interest FTAdviser

[3] 05.09.2023 Best easy access savings accounts Moneyfacts

[4] 05.09.2023 Your Personal Savings Allowance explained Moneyfact

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Benchmark Financial Planning is an Appointed Representative of Best Practice IFA Group Limited which is authorised and regulated by the Financial Conduct Authority, the registration number is 223112. Registered office: Broadlands Business Campus, Langhurst Wood Road, Horsham, West Sussex, RH12 4QP. Registered in England and Wales No 07572431.

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