- As rate-setters meet this week, markets now predict the Bank of England will keep base rate at 5.25% before eventually dropping it in 2024 or 2025
- Almost two years of steady interest rate rises have boosted cash savings rates, but increased the tax bill at the same time
- Higher-rate taxpayers with cash in the best easy-access account in December 2021 (before the current rate hiking cycle) could have up to £77,000 before hitting their tax-free limit
- This limit has dropped to £9,525 today and they will pay tax on only £8,265 of cash savings under current best one-year fix
- Basic-rate taxpayers could have had £154,000 in the best easy access account two years ago before getting taxed – which has shrunk to just over £19,000 today
- HMRC expects over 2.7 million people to be hit by savings tax in 2023-23, up by 1 million compared with estimates for the 2022-23 tax year, according to an FOI obtained by AJ Bell
Laura Suter, head of personal finance at AJ Bell, comments:
“Savings rates have been climbing for almost two years, with many savers now rushing to lock in deals before rates fall. But while savers have been revelling in the news that they can get a meaty return on their savings, many will be hit with a tax bill for their savings interest – in many cases for the first time. The Personal Savings Allowance gives all taxpayers some protection from tax on their savings – but with rates having shot up and the allowance remaining stubbornly still, many will be landed with a tax bill for their savings.
“Almost two years ago, before the current rate hiking cycle, a basic-rate taxpayer could have a whopping £154,000 in savings in the top easy-access account before hitting their Personal Savings Allowance – meaning it was only an issue for the very wealthy sitting on large cash piles in non-ISA accounts. But this has now been slashed to just £19,050 in the top easy-access account – meaning many average earners with an emergency savings pot could be hit with tax.
“For higher rate taxpayers you could save £77,000 in the top easy-access account two years ago, but this has now been slashed to £9,525. If that saver was locking up their money in the top one year fix they could only save £8,265 before hitting their Personal Savings Allowance.
“To add insult to injury, lots of taxpayers will have been pushed into the next tax bracket over the past two years, thanks to frozen income tax bands. This means they will have seen their Personal Savings Allowance cut from £1,000 to £500, if they’ve moved from basic rate to higher rate tax. Or they will have seen the allowance wiped out entirely if they’ve been pushed into the additional rate bracket.
“When base rate was 0.1%, if your savings were earning that amount of interest, a basic-rate taxpayer would need to have £1 million in cash savings to hit their £1,000 tax-free limit. However, fast forward to today and with the top easy-access savings account now paying 5.25% that same basic-rate taxpayer would only need to have £19,050 in savings to hit the limit. What’s more, if that basic-rate taxpayer had seen their income rise in the past few years and had tipped over into the higher-rate income tax bracket, they would only have a £500 tax-free savings limit, meaning they would need to have just £9,525 in savings before they hit their new, lower limit.”
A case for ISAs
“Previously people used cash ISAs for much of their savings, to avoid being hit with a tax bill. But since the introduction of the Personal Savings Allowance many savers shunned ISAs for the ease and higher rates available in non-ISA accounts. But that decision is hitting savers’ pockets now, as many find they have too much money to move it into an ISA in one year. The annual ISA limit of £20,000 is generous, but if you’ve spent years accumulating savings outside of an ISA you might find you hit that limit pretty quickly when you want to transfer your money into the tax efficient account. Cash ISAs also often pay lower interest rates, so savers will need to do their sums to work out whether it’s worth picking a higher paying non-ISA account and paying tax on their savings interest, or putting it in an ISA and accepting a lower rate.
“It’s also worth assessing how much money you really need in cash. Holding cash is smart if you know that you’ll need to spend it in the next few years or to have an emergency pot of cash. Once you’ve satisfied those short-term spending needs you will want to consider whether investing is a better option. Studies of stock market returns over the long term show that they beat both cash and inflation.”
