HM Revenue and Customs (HMRC) has strict rules on how much interest you can earn on your savings accounts before you need to pay tax – here’s how it works
Some savers could find themselves facing tax if they’re fortunate enough to generate substantial interest.
HM Revenue and Customs (HMRC) has explicit rules on how much interest can be accumulated on savings accounts before you need to start paying tax. However, some individuals may worry about potentially getting into trouble for not paying tax on their savings and whether they should report it to HMRC or not.
The amount of tax you owe to the government department will hinge on several factors, including how much you exceed your Personal Allowance, your starting savings rate, and your Personal Savings Allowance.
When you need to inform HMRC about interest earned on your savings
Typically, your bank or building society that manages your savings account will inform HMRC how much interest you have received at the end of each tax year. Consequently, HMRC will contact you to tell you whether you need to pay as well as how you can pay it.
Moreover, if you’re employed or receive a pension, HMRC will adjust your tax code so that you pay tax on your savings automatically. As part of this process, HMRC will estimate how much interest you’ll get in the current year by looking at how much you got the previous year – if you have overpaid or underpaid on your tax from this estimation, you will be sent a tax calculation letter.
However, for those who are self-employed, it’s crucial to report any interest earned on your savings through your annual Self Assessment tax return. Remember, you must register for Self Assessment if your income from savings and investments exceeds £10,000.
Factors that influence the amount of tax you pay on savings
Personal Allowance
The Personal Allowance is the income limit before you’re required to pay tax – currently set at £12,750 a year for most individuals. You can utilise your Personal Allowance to offset tax on your savings interest, but only if it hasn’t already been used on other income sources such as wages or pensions.
Starting rate for savings
The starting rate for savings permits you to earn up to £5,000 in interest before you’re required to pay tax on it. However, this starting rate decreases once you begin earning a certain amount of income from other sources.
If your income is less than £17,570, you will qualify for the maximum starting rate of £5,000, with every £1 of other income above your Personal Allowance reducing the starting rate by £1. Furthermore, once your income surpasses £17,570, you will no longer be eligible for the starting rate.
Personal Savings Allowance
Your Personal Savings Allowance, which determines how much interest you can earn tax-free, depends on your Income Tax band. If you’re in the Basic tax rate band, your Personal Savings Allowance is £1,000.
For those in the Higher rate band, the allowance is £500, while Additional rate taxpayers do not receive a Personal Savings Allowance.
You can find full details on how to calculate whether you’ll pay tax on interest this tax year here.