For years you have probably not really had to worry about paying tax on your savings.  

Interest rates on cash savings have been virtually zero for over 12 years. The last time the Bank of England base rate was over 1% was back in 2009. 

In recent months interest rates have been rising to a point now where at the time of writing you can secure 4.45% for a one year fixed term.  

The problem now is that you might have to start paying tax on your savings and it can get messy dealing with HMRC.  


When you have to pay tax on your savings  


If you hold your savings in a cash ISA then you don’t need to worry right now, all interest paid in a Cash ISA is tax free.  

Any savings outside of an ISA is liable to Income Tax 

There are a couple of allowances we can use against our cash savings.  

For a start there is the Personal Savings Allowance. This allows basic rate tax payers to earn up to £1,000 interest tax free and £500 for higher rate tax payers.  

If you have little or no other income then your savings interest can count towards your Personal Allowance of £12,570 which is the amount you can earn before paying Income Tax.  

There is also the starting rate for savers which means you could receive £5,000 worth of interest tax free if your other income is less than £12,570.  

Any interest on savings earned above these levels will be added on top of your other earnings (including pension and rental income) and be taxed at either 20%, 40% or 45% depending on what level you are. 

For example, Wendy works full time earning £60,000 per year. She also has cash savings outside of an ISA of £50,000.  

Her savings interest rate is 4.45% and therefore she receives interest of £2,225 for the year.  

As Wendy is a higher rate tax payer she can use her £500 Personal Savings Allowance towards the interest.  

This means £2,225 – £500 = £1,725 is subject to Income Tax at 40%. So £690 tax paid in total.  

This brings Wendy’s net interest rate down to 3.07%. 

This tax problem will get worse the higher interest rates rise. 


What you need to do if you need to pay tax on your savings  

A few years back it used to be the case that all savings interest was paid net meaning the bank would automatically deduct basic rate Income Tax from your cash savings.  

Now savings interest is paid gross meaning you need to be on top of how much tax you need to pay and declare it to HM Revenue and Customs (HMRC) appropriately.  

If you earn over £10,000 from your savings and investments then you must register for a self assessment tax return.  

If your earnings from savings and investments are below this amount and you are working or receiving a pension income then HMRC will usually adjust your tax code to recover the tax on your savings.  

They will base this on the interest earned during the previous tax year so if in the next tax year your interest is more or less, things could start to get messy as you over or under pay tax.  

The banks are under orders to report the interest they pay you to HMRC so HMRC should write to you if they feel you owe them tax.  

To make your savings go further it’s important you get as much as you can into ISAs as these are tax free. You can contribute £20,000 into an ISA per tax year. That’s each so a couple could do one each meaning they can get £40,000 into ISAs each year.  

Whilst it’s nice to finally earn some sort of interest on your cash savings remember cash is not ideal for long term returns.  

Whilst 4.45% interest is much better than we have been used to these last 12 years it is still below the current rate of inflation of around 10%. So you are still losing money in real terms.  

Cash is useful for short term spending plans and for emergencies. In order to generate good long term returns over inflation you should consider investing the money into a portfolio that is appropriate for the level of risk you are comfortable with.  

This will lead to a more prosperous retirement and ensure your money lasts longer. 

If you feel you are holding too much cash savings and are not sure on where to invest then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the retirement you desire. We’ve created hundreds of happy retirements, this could be you too! 

Risk warning:

Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.