Find out when you do and when you don’t pay tax on money earned in savings.

With decent savings rates available over the last few years, more and more savers will be paying tax on some of their savings. Here’s what you need to know.

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Who pays tax on interest?

You might not realise it, but interest earned on saving is technically subject to tax at your tax rate. So if you’re a basic rate taxpayer and earn £100 in interest in a financial year, you’d pay £20 of that in tax. Higher rate taxpayers would pay £40.

Fortunately, most of the time this doesn’t apply. There are four ways to avoid this payment to HMRC: Cash ISAs, the Personal Savings Allowance, the starting rate for savings and finally Premium Bonds.

However, each of these are subject to limits on how much is tax-free. When combined with increased interest rates in recent years and frozen tax bands, it could actually mean you will have to pay some tax on some of your interest.

The Cash ISA tax-free allowance

The one most are familiar with is the Cash ISA. An ISA is a type of savings account where the interest is tax-free, and the Cash ISA is (as the name suggests) one for cash savings rather than investments.

There’s an annual ISA allowance, which limits how much you can pay in one each year to £20,000, though that allowance resets for new deposits each April. That means once the money is in an ISA, it will keep earning tax-free interest year after year. You can read more about ISAs here.

This tax-free status is why so many people have the idea in their heads that they need an ISA for their savings. And for a while it was often the best place to stash your cash. But since 2016 (so quite a while now) there’s also been the Personal Savings Allowance (PSA).

The Personal Savings Allowance

Most of you reading this will be entitled to a PSA. This allowance isn’t about how much money you can save tax-free, instead it’s based on how much interest you can earn before tax is due. And it’s a decent amount of up to £1,000 each year.

The Personal Savings Allowance covers a financial year rather than a calendar year. This runs 6 April to the 5 April the following year.

The PSA also only applies to money saved in accounts that aren’t already tax-free, so interest earned on cash in an ISA, for example, is in addition to this.

How much is the Personal Savings Allowance?

If you’re a basic rate taxpayer you have an allowance of £1,000 in interest earned before tax is due. If you’re a higher rate taxpayer, the Personal Savings Allowance is £500. Additional rate taxpayers lose the PSA completely.

It’s only earnings above this which are taxed. So if you get the full £1,000 PSA and earn £1,200 of interest in a financial year, you’ll pay 20% tax on the surplus £200 (adding up to £40).

Someone who only has a £500 allowance would be taxed 40% on £700, meaning they pay £240 in tax. And an additional rate tax payer will pay 45% on all the interest, losing a total of £108 – nearly half their cash.

You can read more about what you’ll need in savings to go over your PSA in our Will you pay tax on savings article.

When interest is available will make a difference

It’s important to note interest counts towards the PSA when it is accessible by you, not when it’s added to your account.

So if it’s paid monthly in an easy access account, it’ll be part of that current financial year. But if it’s an account that pays all in one go (some regular savers and most fixed rate bonds), it’ll all count towards the year that month is in.

It’s worth checking for longer fixes where interest is paid annually whether you can access the interest or not. Some might pay the interest into your

What about joint accounts?

Technically any interest earned in joint accounts is split down the middle. So say the account receives £100 in a year, you’ll both put £50 towards your respective allowances.

Paying tax on savings interest

For interest that goes over your PSA, most people any tax due will be taken back via a change to your tax code. Those who fill in a self assessment form will usually pay the money owed as part of their return. Here’s out comprehensive guide to how this works.

The starting rate for savings tax allowance

There’s a third level that’ll help wipe out tax on interest, and this is for low earners. There’s effectively an extra £5,000 allowance for interest earned, though how much you’ll get depends on your salary.

To be eligible you need to earn less than £17,570 and the total amount is a little complicated. For anyone earning under £12,570 you get the full £5,000 a year allowance.

Then for every £1 you earn over £12,570 (in income other than interest), the starting rate reduces by £1. So someone earning £15,570 a year would lose £3,000 from the allowance, giving them a total of £2,000 extra interest they could earn before tax.

This is in addition to the PSA which would be worth the full £1,000.

Premium Bonds

The final account that’ll pay you tax-free returns is the Premium Bond. Though you’re not guaranteed interest, any prizes you do win are paid tax-free. If you have an average rate of luck and more than £5,000 saved, these should equal or beat the interest rate on the best easy-access accounts.

There’s a limit of £50,000 that can be held by an individual in a PB. Here’s more about how Premium Bonds work and how they compare to savings accounts.