It is a common assumption that you automatically pay tax on the interest your savings earn, but in the UK that is often not the case. Thanks to the Personal Savings Allowance, the vast majority of savers pay nothing at all on the interest they receive from banks and building societies. That does not mean the rules are irrelevant to you, though. With interest rates higher than they were a few years ago, more people are being pushed past their allowance than ever before, and a little awareness of how savings tax works can make a real difference to what you keep.
This guide explains how savings interest is taxed, the allowances that protect most of it, the accounts that are entirely tax-free, and the practical steps you can take to keep the tax bill as low as possible.
How Savings Tax Works
Savings interest is taxed after your Personal Allowance and other income, which is good news for the majority of savers. In practice this means your interest is only drawn into tax once your other income has used up your tax-free allowances. The order in which income is taxed is:
- Personal Allowance (first £12,570 of total income)
- Non-savings income (employment, pension, rental)
- Savings income (interest, dividends)
- Dividend income
The significance of this ordering is that your savings interest only starts being taxed once you have used up your Personal Allowance on other income. For someone who is not working, or whose income is modest, interest can be entirely tax-free even before you bring the Personal Savings Allowance into the picture.
Personal Savings Allowance (PSA)
The Personal Savings Allowance is the mechanism that lets most ordinary savers keep all of their interest. It gives you a set amount of tax-free interest each year, and the size of that allowance depends on your income tax rate:
| Income Tax Band | PSA Amount |
|---|---|
| Basic rate (20%) | £1,000 |
| Higher rate (40%) | £500 |
| Additional rate (45%) | £0 |
Your PSA is based on your total income, not just savings. If you’re a basic rate taxpayer, you can earn £1,000 in interest without paying any tax on it. Higher rate taxpayers get £500, and additional rate taxpayers get no allowance at all.
Example
A simple example shows how most people end up owing nothing:
- Salary: £30,000 (basic rate taxpayer)
- Savings: £20,000 at 5% interest = £1,000
- PSA covers the full £1,000
- Tax on savings: £0
With a basic rate allowance of £1,000, your full year’s interest is sheltered. The moment your interest exceeds the allowance, though, the excess becomes taxable at your income tax rate.
Starting Rate for Savings
For people on lower incomes, there is an additional layer of protection known as the starting rate for savings. If your total income is low, you may get up to £5,000 of tax-free interest on top of everything else.
You qualify if your total income (excluding savings) is below £17,570. The starting rate reduces by £1 for every £1 of non-savings income above the Personal Allowance, so it is gradually tapered away as your earnings grow.
Example:
- Non-savings income: £14,000
- Personal Allowance: £12,570
- Non-savings income above PA: £1,430
- Starting rate for savings: £5,000 - £1,430 = £3,570
You’d also have your £1,000 PSA on top, giving you £4,570 of tax-free interest. For a low earner with meaningful savings, this combination can comfortably shelter most or all of the interest received.
Tax-Free Savings Accounts
Some savings are completely exempt from tax, and these are worth knowing about because they can dramatically simplify your tax situation.
Individual Savings Accounts (ISAs)
ISAs let you earn interest or investment returns tax-free. The annual allowance is £20,000 across all ISA types:
- Cash ISA — Earns interest tax-free
- Stocks & Shares ISA — Investments grow tax-free
- Lifetime ISA — For under-40s, 25% government bonus
- Innovative Finance ISA — Peer-to-peer lending tax-free
Because ISA interest never counts towards your Personal Savings Allowance, there is no tax to work out at all.
NS&I Premium Bonds
Premium Bonds are tax-free. Any winnings from the monthly prize draw are not subject to income tax or capital gains tax. Rather than paying regular interest, they enter you into a monthly prize draw where prizes are paid tax-free in full.
Other Tax-Free Savings
A few other accounts also enjoy tax-free status:
- Help to Save (for Universal Credit claimants)
- Child Trust Funds and Junior ISAs
- Interest on qualifying loans (Advanced Life Limited)
How to Reduce Your Savings Tax Bill
If your interest is starting to edge past your allowance, several straightforward steps can bring the bill back down or eliminate it altogether. None of them involve aggressive or complicated planning.
Use Your ISA Allowance
ISAs are the simplest way to shelter savings from tax. You can put up to £20,000 per tax year into ISAs, and everything you earn inside them is tax-free.
Tip: If you have £20,000 in savings earning 5%, that’s £1,000 interest. In an ISA, it’s completely tax-free — so it doesn’t use up any of your Personal Savings Allowance on top of that.
Maximise Your PSA
Make sure you’re not earning interest in accounts that don’t qualify for PSA. Most bank and building society accounts qualify, but some offshore accounts don’t. It is easy to assume every account is covered, but it is worth checking the small print of any account based offshore.
Split Savings Between Spouses
If one partner uses their PSA and the other doesn’t, consider transferring savings to the lower earner. There’s no tax on transferring between spouses, and doing so lets you make use of both Personal Savings Allowances rather than wasting the lower earner’s.
Use Premium Bonds
If you’ve maxed your ISA allowance, Premium Bonds offer tax-free returns (though average returns are lower than cash ISAs). They are a reasonable home for money that would otherwise generate taxable interest, particularly for higher and additional rate taxpayers whose PSA is reduced or zero.
Consider Timing
If you’re likely to move into a higher tax band, consider using your ISA allowance before the end of the tax year. Moving money into an ISA before a change in circumstances protects the interest from the higher rate, and the annual ISA allowance does not carry over, so it is worth using it each year while you can.
Example: How Tax on Savings Works
Bringing it together with a case that reflects a higher earner:
- Salary: £55,000 (higher rate taxpayer)
- Savings: £30,000 at 4.5% = £1,350 interest
Tax calculation:
- Your PSA: £500 (higher rate)
- Taxable interest: £1,350 - £500 = £850
- Tax at 40%: £340
If that same £30,000 was in a Cash ISA:
- Interest: £1,350
- Tax: £0
The difference is striking: £340 of tax avoided simply by holding the same money in the right type of account. This is the central lesson of savings tax in the UK — the rules are generally generous, but they reward savers who use their ISA allowance and understand their allowance limits.
Closing Thoughts
For most people, savings tax is barely an issue thanks to the Personal Savings Allowance and the tax-free nature of ISAs. The practical task each year is simple: check your savings interest against your PSA, and if you are close to (or above) the limit, consider moving excess savings into an ISA or transferring money to a spouse with unused allowance. The numbers in this guide reflect the rules as commonly applied, but tax rules do change, so it is always worth checking the current figures on GOV.UK. This guide is educational rather than advice, and for anything unusual or valuable you should consider speaking to an accountant or financial adviser.