The Personal Savings Allowance (PSA) is a tax-free allowance provided by the Government to encourage saving. However, the balance required to breach an individual’s PSA has reduced as rates have increased.

The number of people exposed to paying tax on their savings has tripled over the past year, according to our analysis. 

We look at what the PSA is, how it affects savers and actions individuals can take to mitigate its impact.

What are the Personal Savings Allowance thresholds?

The PSA allows individuals to earn a certain amount of interest on their savings without having to pay income tax on it. The current thresholds are:

• Basic-rate taxpayers: Up to £1,000 of interest income is tax-free
• Higher-rate taxpayers: Up to £500 of interest income is tax-free
• Additional-rate taxpayers: There is no PSA, meaning all interest income is subject to income tax

Who is eligible for the PSA?

Individuals who are basic-rate and higher-rate taxpayers are eligible for the PSA. However, it is not available to those who are not liable to pay income tax, such as non-taxpayers, or those whose total income falls within the Personal Allowance limit, which is £12,570 for the current tax year.

What interest is covered by the PSA?

Interest generated from the below sources contributes towards an individual’s PSA:

• non-ISA bank and building society accounts
• savings and credit union accounts
• unit trusts, investment trusts and open-ended investment companies
• peer-to-peer lending
• trust funds
• payment protection insurance
• government or company bonds
• life annuity payments
• some life insurance contracts

Why has the number of people paying tax on their savings interest increased?

As rates have risen, the balance required to exceed the PSA threshold has reduced. According to Moneyfacts, the average one-year fixed-rate bond is paying 4.71% (as at 30 Jan 2024), meaning a higher-rate taxpayer would need a balance of just £10,650 to breach their PSA. Any savings on top of that would be liable for tax at the 40% higher-rate band.

When is tax payable?

Savers are liable for the tax payment during the tax year they can access the interest.

For example, if a saver opens a two-year fixed-rate account and takes interest on maturity, they would be liable to pay the tax during the tax year that the product matures. 

How do you pay tax on savings?

Banks and Building Societies report all untaxed interest paid out after the end of each tax year to HMRC. If you’re employed or receive a pension, HMRC will normally change your tax code so you pay tax on any interest automatically. If you complete a Self-Assessment Tax Return, you should report any interest earned on savings there.

What about joint accounts?

When you share a joint bank account, the interest earned is typically divided equally between the account holders and allocated to their respective PSAs.

For instance, if both account holders are classified as higher-rate taxpayers and the total interest earned is £1,000, this amount will be split evenly between the two individuals, utilising £500 of each person's individual PSA. As the PSA for higher-rate taxpayers stands at £500, this results in no tax being payable on the interest.

Now, let's consider a scenario where one account holder is a basic-rate taxpayer, and the other is a higher-rate taxpayer. In this case, the interest earned on the joint account would still be divided equally between the two parties.

If we assume again that the interest earned on the joint account is £1,000, the basic-rate taxpayer, who has a PSA of £1,000, will still have £500 of their tax-free interest allowance remaining. However, the higher rate taxpayer's PSA of £500 will have been entirely utilised with the allocation from the joint account.

How can you reduce tax on savings interest?

There are two options for savers to consider.

The first is saving into an ISA. Savers can place £20,000 into a cash ISA each tax year and protect their returns.

Another option savers should consider is how they receive their interest, particularly within longer-term fixed-rate accounts. Savers can typically choose to receive interest payments on a monthly or annual basis, although some providers will only allow customers to receive interest on product maturity.

Savers can also usually choose to accumulate the interest back into the fixed-rate account – so they don’t access the cash - or ‘pay away’ the interest to a nominated account, where they would have access to the money.

Under the PSA, the tax liability falls during the tax year the interest is accessible.

Therefore, savers with a fixed-rate product with a maturity date longer than one year need to factor in how the method of interest payment will impact their PSA threshold. Our guide – Stay or pay away – explains this in more detail.

All statistics are correct at the time of writing. For tax advice, please seek the support of a professional tax advisor.