HM Revenue and Customs has issued an advisory to individuals regarding the tax-free limits on savings interest. Under current UK tax law, savers may earn a specific amount of interest before becoming liable for income tax.
The maximum tax-free limit depends on several factors, including a person's income and use of their personal allowance. Authorities state that those exceeding the £5,000 starting rate may find themselves subject to additional taxation on interest.
The guidance aims to clarify how different allowances operate, helping savers understand their obligations and avoid unexpected tax bills.
Overview of Savings Interest Tax Rules
HMRC’s notice underscores the framework for taxing interest earned on personal savings. The tax-free thresholds hinge on total income, and individuals with lower overall earnings tend to benefit from more generous interest allowances. HMRC has emphasised that most savers fall within these allowances and will not automatically be taxed on savings interest.
To support taxpayers, the government provides three primary tax-free allowances relating to savings: the personal allowance, the starting rate for savings, and the personal savings allowance. Official data confirm these thresholds are regularly reviewed but have remained unchanged since being frozen by the Chancellor in the 2023 Autumn Statement.
Personal Allowance and Tax-Free Interest
The personal allowance currently stands at £12,570 per year. This is the amount a person can earn, across wages, pensions, or other income, without incurring income tax.
If an individual’s total income is less than this figure, all their savings interest also remains tax-free. When a person’s income exceeds £100,000, the personal allowance is reduced. Income tax bands differ in Scotland, but the standard
UK allowance generally applies. This arrangement will remain in place until the 2030–31 tax year, following the government’s recent decision to maintain the present levels.
How the Starting Rate for Savings Works
The starting rate for savings allows an additional tax-free interest threshold of up to £5,000 for those on lower incomes.
If earnings from work or pensions are less than the personal allowance, the individual can benefit from the full £5,000 starting rate for savings meaning up to £5,000 in interest may be earned tax-free. Once earnings surpass £12,570, the starting rate for savings is gradually reduced.
For every £1 earned over the personal allowance, the starting rate is reduced by £1. Those with total income of £17,570 or above do not qualify for any portion of this rate. HMRC advises that understanding this taper is critical to avoid unintended tax liabilities as income increases.
Personal Savings Allowance Explained
All basic-rate taxpayers defined as those with total income between £12,570 and £50,270 are entitled to a personal savings allowance (PSA) of £1,000 per year.
This allowance applies over and above the individual’s personal or starting rates. For higher-rate taxpayers (earning between £50,270 and £125,140), the PSA is reduced to £500. Additional-rate taxpayers (earning over £125,140) are not entitled to any PSA.
These allowances provide a tax-free buffer for savings interest, but amounts above these limits are subject to the standard tax rate.
Types of Interest Income Covered
The allowances cover interest received from a wide range of sources. These include bank and building society accounts, credit unions, trust funds, investment vehicles such as unit or investment trusts, open-ended investment companies, peer-to-peer lending, and government or corporate bonds.
Interest arising from some life insurance contracts and annuities may also be exempt within the applicable allowance. This coverage aims to simplify tax arrangements for individuals with diversified savings and investment portfolios. Payment protection insurance compensation and certain other products also fall within the remit, subject to HMRC rules.
Final Summary
The government continues to provide a tiered set of tax-free savings allowances to encourage personal saving whilst ensuring higher earners contribute additional tax on interest.
The personal allowance, starting rate for savings, and personal savings allowance together form the foundation of the UK’s approach to taxing savings interest. With allowances frozen until 2031, taxpayers should review their incomes annually to ensure compliance, as exceeding these limits can lead to unexpected tax obligations.
Savers are encouraged to utilise official tools and applications such as the Pie app to help track allowance usage and potential tax exposure in real time.
