Personal Savings Allowance: How the Frozen Tax Rule Affects UK Savers

Personal Savings Allowance: How the frozen tax rule affects UK savers

For many people in the UK, earning interest on savings is a welcome boost to their finances. However, a tax rule called the Personal Savings Allowance (PSA) has remained unchanged since 2016, while savings rates have risen significantly. This means millions more savers are now paying tax on their interest for the first time, a situation highlighted by recent reports. Understanding this rule is crucial for anyone with savings, as it directly impacts how much of your interest you get to keep.

This guide explains what the Personal Savings Allowance is, who it affects, and the practical steps you can take to manage your tax liability. It’s not about market speculation, but about clear, practical guidance on a rule that affects everyday finances.

What is the Personal Savings Allowance?

Introduced in April 2016, the Personal Savings Allowance is a UK tax rule that allows most people to earn a certain amount of interest from savings each year without paying any tax on it. It was designed to simplify the tax system for savers. Crucially, the allowance is not an additional tax-free amount you can claim; it works by setting a threshold before tax becomes due.

The amount of allowance you get depends on your income tax band:

Basic-rate taxpayers

If your annual income is between £12,571 and £50,270 (for the 2024/25 tax year), you are a basic-rate taxpayer. Your Personal Savings Allowance is £1,000. This means you can earn up to £1,000 in savings interest across all your accounts before you start paying tax on it.

Higher-rate taxpayers

If your annual income is between £50,271 and £125,140, you are a higher-rate taxpayer. Your allowance is lower, at £500.

Additional-rate taxpayers

If your annual income is over £125,140, you are an additional-rate taxpayer. You do not receive a Personal Savings Allowance and will pay tax on all your savings interest.

Why are more people paying tax on savings now?

The core issue is that the allowance amounts (£1,000 and £500) have been frozen since they were set in 2016. Meanwhile, after a long period of very low rates, the Bank of England’s base rate has increased significantly since late 2021. This has led to much higher interest rates being offered on savings accounts.

For example, with a £50,000 savings pot earning 5% interest, you would generate £2,500 in interest in a year. A basic-rate taxpayer would use their entire £1,000 allowance and then have £1,500 of taxable interest. This scenario was far less common when average savings rates were below 1%.

This freeze, while savings rates rise, is what is described as ‘fiscal drag’ – where more people are pulled into paying a tax because the threshold doesn’t keep pace with economic changes.

How is savings interest taxed?

If your total savings interest exceeds your Personal Savings Allowance, you will pay tax on the excess at your usual income tax rate (20%, 40%, or 45%). It’s important to note that this is not a separate ‘savings tax’; it is part of your overall income tax calculation.

Most banks and building societies pay interest without deducting tax. It is your responsibility to declare any taxable interest to HMRC. They will usually adjust your tax code to collect the tax owed, or you may need to complete a Self Assessment tax return if your affairs are more complex.

What can UK savers do about it?

While you cannot change the frozen allowance, there are several legitimate strategies to reduce or eliminate your tax bill on savings interest.

Utilise your ISA allowance

This is the most effective tool. Interest earned within a Cash ISA is completely tax-free, and it does not count towards your Personal Savings Allowance. Every UK adult has an annual ISA allowance (currently £20,000), which you can use for cash, stocks and shares, or a combination. Moving savings into an ISA, especially for higher balances, can shield your interest from tax entirely.

Consider your spouse or partner’s allowance

If you are married or in a civil partnership, you may be able to distribute savings between you to make use of both of your Personal Savings Allowances and ISA allowances. There are specific rules around gifting money, so it’s important to ensure any transfers are genuine gifts with no strings attached.

Check your starting rate for savings

If your total annual income is below £17,570, you may also qualify for the ‘starting rate for savings’. This can give you an additional tax-free allowance of up to £5,000 on savings interest, on top of your Personal Savings Allowance. The amount you get depends on your other income.

Review where you hold your savings

If you are nearing your allowance limit, you might prioritise holding savings that pay the highest interest within an ISA wrapper, while keeping other funds in standard accounts.

Key takeaways for UK consumers

The frozen Personal Savings Allowance means that with higher interest rates, it is easier than ever to generate a tax bill on your savings. It’s essential to be aware of your total interest income across all accounts and understand which tax band you fall into. Proactively using tax-efficient wrappers like ISAs is the most straightforward way to protect your interest from tax. Always remember that tax rules depend on your personal circumstances, and if you are unsure, seeking guidance from a qualified financial adviser is recommended.

Personal Savings Allowance: How the Frozen Tax Rule Affects UK Savers