In our weekly series, readers can email any question about their finances, to be answered by our expert, Rosie Hooper. Rosie is a chartered financial planner at Quilter Cheviot Financial Planning and has worked in financial services for 25 years. If you have a question for her, email us at money@inews.co.uk
Question: I have earned interest from my savings last year, and the amount is greater than £1,000. I know I owe tax on this but I’m employed, so all my tax comes out as PAYE. Do I need to do anything to make sure the tax I owe on my savings is paid or does it happen automatically?
Answer: For the first time in more than a decade, thousands of savers are finding themselves unexpectedly facing a tax bill. Rising interest rates have meant many people earned more in savings interest than they have in years, and in some cases, more than their tax-free allowance permits.
If you’re a PAYE taxpayer who doesn’t usually file a tax return, and you’ve heard rumblings about having to report savings income, you’re not alone. Here’s what you need to know—and why, for most people, there may be nothing to worry about.
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Over the past two years, inflation has been stubbornly high. In response, the Bank of England raised interest rates from historic lows to combat rising prices. That’s pushed up the returns on everything from fixed-rate bonds to easy-access savings accounts.
As of this week, UK inflation came in at 2.6 per cent, but with interest rates still elevated, many savers are continuing to benefit from higher interest rates.
However, global uncertainty has increased significantly recently. The potential for a trade war between the US and China has wobbled markets and raised concerns about slowing global growth. If the UK economy weakens in response, interest rates may fall again. For now, many savers are enjoying better returns, but this comes a potential tax headache.
If your total income, including savings interest, falls within the basic rate band, then the first £1,000 savings interest is tax free thanks to the Personal Savings Allowance (PSA). If your total income, including savings interest, falls within the higher rate band, then the first £500 is tax free.
So, if your earnings are usually in the upper end of the basic rate band and you get a surprisingly high amount of interest for the year, then you could become a higher rate taxpayer, then lose half the PSA. Additional rate taxpayers get no PSA. These rules for the various tax bands apply to interest earned on non-ISA accounts such as fixed savings and even current accounts that pay interest.
With some easy-access accounts now offering over 4 per cent and fixed-rate bonds nudging towards 5 per cent or more, it doesn’t take a vast fortune to breach the threshold. For example, a savings pot of around £10,000 earning 5 per cent could already generate £500 in interest – enough to tip a higher-rate taxpayer into taxable territory. And for a basic-rate taxpayer, it would take just over £20,000 earning 5 per cent to exceed the £1,000 limit.
The good news is that in most cases you don’t need to do anything about this. If your savings interest has gone over your allowance, and you’re taxed via PAYE (your tax is deducted directly from your wages or pension), HMRC will normally adjust your tax code automatically. Banks and building societies report your interest income to HMRC, and they use this to update your tax code for the following year to collect the tax owed.
You might see a slight drop in your monthly pay as a result, but it’s designed to spread the bill out gradually. You don’t usually need to file a tax return or notify HMRC unless something unusual has happened.
So when would I need to take action?
There are a few exceptions where you might need to get in touch with HMRC or even register for Self Assessment:
• If your interest income is from multiple accounts and providers, and HMRC doesn’t catch it all.
• If you received interest from overseas accounts.
• If you earned more than £10,000 in total from savings and investments (including dividends).
If you think you fall into any of these categories, contact HMRC or check your Personal Tax Account online to see what they have on record. If a discrepancy arises, it’s better to deal with it proactively than wait for a letter down the line.
If you don’t owe tax and HMRC has everything it needs, no action is needed. But if you do owe tax and fail to report it or respond to HMRC queries, you could face late payment interest or even a penalty. So it’s worth double-checking your interest earnings for peace of mind.
One way to avoid this situation in future is to make better use of ISAs. Interest earned in a cash ISA doesn’t count towards your Personal Savings Allowance and is completely tax-free. That said, cash ISAs don’t always offer the highest rates, so it’s worth shopping around.
If you’ve already built up a healthy cash buffer (three to six months of expenses is a good rule of thumb), you might want to consider moving some of the excess into a Stocks and Shares ISA. These carry investment risk but can offer better long-term growth than cash, particularly once inflation and tax are taken into account.
The rise in interest rates has been a welcome break for savers, but it comes with tax consequences that many aren’t used to. For most PAYE earners, there’s no need to panic—but do check what you earned in interest last year. With a bit of attention and some smart planning, you can keep more of your money working for you, without surprises from the taxman.
