Tax on savings explained

Everybody knows that their personal and company incomes are taxable. But many people don’t realise they might have to pay tax on savings interest, too.

Do you have savings in an account that pays interest? If the answer is yes, you might need to report the interest you earn to HMRC – and pay tax on it.

Keep reading to learn what savings interest tax is, when you have to pay it (and how), how much tax-free savings interest you can earn – and more.

What is tax on savings interest?

Tax on savings interest is income tax you pay on interest earned from money held in a savings account. This interest is classed as income, just like a salary.

Whether you need to pay savings interest tax or not – and how you must pay it – will depend on a number of factors, including:

• whether the savings account belongs to you, or your limited company
• the type of savings account you have
• your employment status, and
• your total income (or company profit).

When you have to pay tax on savings interest

If you’re an employee or a sole trader who pays income tax on your earnings, any savings interest you earn above a certain limit counts towards your taxable income.

The same rule applies to paying tax on savings when retired. If you receive a pension, interest from savings is added to this income to calculate your tax bill.

And if you’re a limited company director with company money in a business savings account, interest earned is classed as company revenue – and may be subject to corporation tax.

When and how you pay savings interest tax depends on the factors outlined above, and whether you qualify for certain government allowances.

Let’s take a closer look at those allowances.

How much tax-free savings interest you can earn

Most people can earn some interest on their savings without having to pay tax. Those with very low incomes can earn up to £18,570 in tax-free savings interest.

But if you earn even an average salary, you’re allowed to earn significantly less as the main government allowances are linked to your total taxable income.

There are three main government savings allowances:

Your personal allowance for income

Most of us can earn £12,570 of tax-free income each year, and this includes income from savings interest. This is known as the personal allowance.

But with the average annual UK salary at around £35,000, many working savers have the personal allowance used up by their first £12,570 of wages.

The starting rate for savings

If your non-savings income is less than £17,570 a year, you can earn up to £5,000 in savings interest tax-free. This is known as the starting rate for savings.

Your exact starting rate for savings will depend on the difference between your total non-savings income, and your £12,570 personal allowance (see example 1 below).

Your personal savings allowance

Just as most people can earn £12,570 a year before they pay income tax, most of us can also earn a certain amount of interest on our savings tax-free.

This is known as your personal savings allowance, and the amount of interest you’re allowed to earn depends on which income tax band you fall into:

Let’s look at some examples of how these allowances work.

Example 1

Your salary is £15,000, which is £2,430 more than your personal allowance.

This reduces your starting rate for savings to £2,570 (£5,000 minus £2,430).

You’re also eligible for a £1,000 personal savings allowance, because you pay basic rate income tax.

You earn £2,000 in savings interest.

You do not have to pay tax on your savings interest.

Example 2

Your salary is £30,000.

Your salary uses all of your personal allowance, and makes you ineligible for a starting rate for savings.

But you are eligible for a £1,000 personal savings allowance, because you pay basic rate income tax.

You earn £750 in savings interest.

You do not have to pay tax on your savings interest.

Example 3

Your salary is £60,000.

Your salary uses all of your personal allowance, and makes you ineligible for the starting rate for savings.

But you are eligible for a £500 personal savings allowance, because you pay higher rate income tax.

You earn £3,000 in savings interest.

You have to pay tax on £2,500 of savings interest.

Example 4

You earn no income (£0) from non-savings sources.

You can earn £18,570 in savings interest without paying tax, by using:

• your entire £12,570 personal allowance for income
• the maximum £5,000 starting rate for savings, and
• your £1,000 personal savings allowance.

What counts as savings income

Any interest you earn on deposits in savings, bank, building society and credit union accounts counts as savings income and is used to calculate your income tax bill.

But the allowances outlined above also apply to interest earned from other types of savings and investment products, including:

• open-ended investment companies (OEICs)
• investment trusts and unit trusts
• peer-to-peer lending (P2P)
• government or company bonds
• life annuity payments and some life insurance contracts.

Find detailed information on tax on savings and investment at GOV.UK.

How to pay tax on savings interest

Whether you have to notify HMRC of savings interest, and how you pay any tax you owe, depends on your employment status and who the savings belong to.

Here’s how HMRC collects tax on savings interest from different groups.

Employed or receive a pension

If you receive a salary or a pension and pay income tax via PAYE (Pay As You Earn), HMRC will change your tax code and collect any tax you owe automatically.

You do not need to manually report your savings interest or make a tax payment.

Self-employed and complete a self assessment

If you’re self-employed and you report your income via a self-assessment tax return, you must include on your form any interest earned from savings held in your name.

HMRC will then account for any tax you owe in your annual income tax bill.

Director of a limited company

If you’re a director of a limited company and you hold company money in a business savings account, you must report any interest earned on your company tax return.

HMRC will then account for any tax you owe in your annual corporation tax bill.

Tax-free savings products

Not all savings interest income is taxable. Certain types of savings accounts are designed to encourage saving by making any interest you earn tax-free.

With an ISA (Individual Savings Account), you can save up to £20,000 each tax year without having to pay tax on the interest you earn. Similarly, the government-backed savings bank NS&I offers a number of tax-free savings products. Find out more about tax-free saving with NS&I.

Wrapping up

So, there you have it. Hopefully you have a much better understanding of how tax on savings interest works – and whether you have to pay it.

Need somewhere to keep your spare business funds? Open a Tide Instant Saver account and earn 4.33% AER on up to £75,000 of deposits. You can access your funds at any time, and you won’t be charged for withdrawing them. Find out more about our business savings account.