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What to do if you owe tax on savings interest
If you're filing a self-assessment tax return, it's your job to report any savings income
In the rush to file your tax return before the 31 January deadline, don't forget to check your savings income. Recent soaring savings rates mean even those with modest pots may now face a bill from HMRC on interest earned.
A Which? survey of 1,269 members in November 2024 found just under a third of respondents are submitting a tax return this month. Of these, 57% need to pay tax on savings interest or investment income.
Here, Which? explains how tax on savings interest works and explores ways to reduce future bills.
How does tax on savings interest work?
You'll only begin paying tax on savings income once your taxable income exceeds your personal allowance, the starting rate for savings and the personal savings allowance (PSA).
You can use your personal allowance (£12,570 in 2024-25) to earn income from savings tax-free if you have not used it up on your wages, pension or other income.
The starting rate for savings is a tax break on interest worth up to £5,000, aimed at those on a lower income. Every £1 of income above your personal allowance reduces your starting rate for savings by £1.
This effectively means that you can earn up to £17,570 in 2024-25 before having to pay any tax on savings interest.
However, if your income exceeds the personal allowance and you don't qualify for the starter rate for savings, you could shield your savings from tax using the personal savings allowance (PSA). This currently stands at £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers do not have a PSA, meaning all of their returns are subject to tax.
Any interest that exceeds your PSA will be charged at your usual rate of income tax (20%, 40% or 45%).
- Find out more: Tax on savings interest and investment income explained
When will you start paying tax on savings?
In the past, only savers with a large lump sum had to worry about exceeding the PSA, but a rising number of people are now falling into the savings tax trap. HMRC predicts it will take 10 times more tax on savings interest in 2024-25 than four years ago.
There are two main reasons for this:
- Savings boom: Savings rates have hit record highs over the past few years. In October 2022, the best one-year fix offered an impressive 6.2% AER. Rates have dropped considerably since that peak, but you can still find an equivalent account with a top rate of almost 5%. The result is that even savers with modest pots are facing tax bills.
- Threshold freeze: Wage increases and frozen income tax thresholds since April 2021 are dragging more people into a higher tax band. These savers have a smaller PSA to play with as a result.
This table shows how much a basic rate and higher-rate taxpayer needs in savings, at various interest rates, before interest is taxed.
| AER | Savings balance for a basic-rate taxpayer | Savings balance for a higher-rate taxpayer |
|---|---|---|
| 1% | £100,000 | £50,000 |
| 2% | £50,000 | £25,000 |
| 3% | £33,333 | £16,666 |
| 4% | £25,000 | £12,500 |
| 5% | £20,000 | £10,000 |
- Find out more: How much tax do you pay?
What about income from investments?
Your PSA also covers some types of investment income.
Government bonds (gilts), corporate bonds, purchased life annuities and some life insurance contracts all count.
And you also won't need to pay any tax on the first £500 of dividend income you receive in 2024-25, regardless of your tax bracket. This is called the tax-free dividend allowance.
- Find out more: Tax-free income and allowances
How do you pay the bill?
If you're employed, HMRC will automatically collect the tax you owe through pay-as-you-earn (PAYE), usually by tweaking your tax code. But if you're paying your tax using self-assessment, then it's your job to report your savings and investment income as part of your tax return.
Banks and building societies send savings interest data to HMRC after the end of the tax year. The tax office will then use that information to estimate how much tax you owe and then check the figure you declare on your return matches.
- Find out more: How to fill in a self-assessment tax return
3 ways to reduce tax on savings
You can't change this year's tax return bill, which is based on 2023-24 income, but there are steps you can take to reduce the amount HMRC can take from future savings:
1. Open a tax-free savings account
Opening an Isa allows you to deposit £20,000 a year tax-free. You can choose from cash Isas, lifetime Isas, stocks and shares Isas and innovative finance Isas. And as long as you don't go over the £20,000 limit, you can save into several different account types.
Premium bonds are another popular way to save without a tax burden. You can hold up to £50,000 in an account with National Savings & Investments and could win up to £1m in the monthly prize draw.
The downside is that the chances of winning any cash prize are slim – just 22,000 to 1 – and you won't earn any interest on your investment.
- Find out more: Best Cash Isas
2. Split and save
Splitting your savings across several fixed-rate accounts of varying terms means you can spread out the interest payments across different tax years, and potentially reduce your tax bill.
For example, provided you don't need immediate access to the money, a large lump sum could be distributed evenly across one, two, three, four and five-year fixed-term savings accounts.
If you choose to have the interest paid upon maturity, then the income earned on your nest egg will also be spread across several different tax years and won't take such a big bite out of your PSA.
- Find out more: Best savings account 2025
3. Apply for a refund
If you find you've paid too much tax on your savings interest, then you might be able to claim it back from HMRC – either via self-assessment or, if you're employed, by filling in an R40 form.
Remember, if you think you made a mistake after submitting your tax return, you can correct it within 12 months of the self-assessment deadline – either online or by sending another paper return.
If you need to make a change to a return from an earlier tax year, you’ll need to write to HMRC. You can claim tax back on savings from up to four tax years ago. It normally takes around six weeks to get your money back.
