Amidst higher interest rates that have brought increased returns for savers, a growing number of savers have paid tax on their returns over the past year.

According to our recent survey of more than 1,500 savers, over a third of savers (37%) generated enough interest on their savings to hit their Personal Savings Allowance (PSA) in 2023.

This figure is particularly alarming as it indicates that nearly a third of those reaching the PSA did so for the first time, reflecting the increasing impact of our recent higher rate environment on savers' incomes.

The surge in PSA breaches can be attributed primarily to higher interest rates, with 43% of those affected citing this factor. However, increased saving balances also played a role, with 22% of respondents attributing hitting their PSA to this factor.

This suggests that savers, encouraged by higher interest rates, have been putting more money into cash savings, pushing them closer to the PSA limit.

For basic-rate taxpayers, the PSA currently stands at £1,000, shielding a portion of their savings interest from income tax. However, for higher-rate taxpayers, the PSA is significantly lower at £500, making them more vulnerable to tax implications. Additionally, additional-rate taxpayers do not have a PSA, meaning all their savings interest is liable to income tax.

Taking steps

In recognition of the potential tax implications, savers are taking steps to mitigate their exposure. Over half (53%) have opted to transfer existing non-ISA savings into ISAs, which offer tax-free growth. Additionally, 40% have opened new cash ISAs specifically to shelter their savings from tax.

A smaller proportion of savers have adopted a more diversified approach, investing in a mix of tax-free and taxable savings accounts. Others have taken a more cautious approach, spreading out the interest payments from fixed-rate term accounts by moving funds into separate accounts on a monthly or annual basis.

Encouragingly, a majority of proactive savers surveyed (58%) are maximising their annual £20,000 ISA allowance, demonstrating their awareness of the tax benefits associated with ISAs.

Among these savers, 67% prefer to make a lump sum deposit at the start of the tax year, while 30% opt for a year-end deposit. The remaining 14% adopt a more balanced approach, saving regularly throughout the year.

Derek Sprawling, Paragon Bank's Savings Director, commented: "The Personal Savings Allowance has largely flown under the radar in recent years due to the low-interest rate environment, but higher rates have brought it back into focus. With three out of ten savers now paying tax on their savings interest, it's crucial to employ tax-efficient strategies, such as using ISAs, to protect your hard-earned savings. Considering having interest ‘paid away’ on longer-term bonds is another option."

He added: “Paragon Bank has long championed the tax-free benefits of ISAs, advocating for their use even in periods of low-interest rates. ISAs remain an essential tool for savers seeking to safeguard their financial well-being. It is crucial for savers to be aware of their PSA limits and take steps to protect their savings from unnecessary taxes.”

Find out more about how the PSA works, as well as how ‘paying away’ could reduce your tax burden.