Watch Out for the Savings Tax Trap
Rising interest rates and frozen tax allowances are catching UK savers off guard. The savings tax trap is real—many are now hit with surprise tax bills. Even smaller savings accounts can now produce enough interest to cross tax-free limits. Understanding the trap is the first step to keeping more of your savings safe.
Understand How It Works
Your Personal Savings Allowance (PSA) sets how much interest you can earn tax-free.
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£1,000 for basic-rate taxpayers
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£500 for higher-rate taxpayers
With average rates around 4-5%, even a £10,000 balance can bring in taxable interest. Learn more about how savings are taxed at GOV.UK.
Tip 1: Open a Tax-Free ISA
One of the best ways to keep interest tax-free is by using a Cash ISA. You can save up to £20,000 per year, and all interest is tax-exempt. While rates may be slightly lower than regular accounts, the tax savings often make it worthwhile.
Tip 2: Consider Premium Bonds
Premium Bonds from NS&I offer prize-based rewards instead of interest. All prizes are tax-free, and they don’t count against your PSA. This makes them a good option if you’re near or over your allowance.
Tip 3: Increase Pension Payments
Putting more into your pension can reduce your taxable income, helping you stay in a lower tax band. That means you keep more of your PSA and avoid entering the savings tax trap.
Tip 4: Overpay Your Mortgage
Instead of leaving extra cash in a taxed savings account, consider paying off your mortgage early. You’ll save on loan interest and dodge taxes on savings returns.
Tip 5: Use Fixed-Rate Savings—Carefully
Fixed-rate savings accounts often offer higher interest, but be mindful of your total returns. If your yearly interest crosses your PSA, you could be taxed—even if you can’t access the money yet.
Tip 6: Use the Marriage Allowance
If your spouse earns less, they may be able to transfer £1,260 of their tax-free allowance to you. This can reduce your income tax by up to £252 annually, potentially keeping your savings interest under the taxable threshold.
Fiscal Drag Makes It Worse
More people are getting pulled into higher tax brackets due to fiscal drag—where income rises but tax bands stay frozen. That shrinks your PSA and increases the chance of falling into the savings tax trap.
Final Thoughts
Avoiding the savings tax trap isn’t difficult—but it does take planning. From ISAs and pensions to bonds and mortgage strategies, there are many ways to protect your savings. Regularly review your financial situation and stay informed to keep your money working for you—not HMRC.
