It might be old news but it’s creeping closer and closer. By the end of this tax year, HMRC are expected to rake in a record £10.4bn in savings interest tax. With this rising by a tear-jerking 740% since 2021, it’s crucial savers know what they can do to reduce the impact.
Thankfully, there’s a silver lining – there are ways savers can shelter their cash and avoid the possibly painful increases.
This article isn’t personal advice. If you’re not sure if an action is right for you, ask for advice.
What’s caused the increases?
Before diving into the ways savers can lower their tax, it’s worth exploring the reasons behind the rise.
The main culprit is ‘fiscal drag’.
It’s caused by rising wages and frozen tax thresholds.
Originally under the Conservatives in 2022, and now under Labour in their first budget in 2024, both governments opted to freeze the tax thresholds at their current rates until 2028. This included allowances like the personal allowance, higher-rate thresholds, and the personal savings allowance. The additional-rate tax threshold was also lowered.
More money is brought into the treasury without it having to raise tax rates, a key election promise from Labour.
Currently, the personal savings allowance is £1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers, and additional-rate taxpayers don’t have a personal savings allowance at all. The result? A rapid rise in tax on savings.
Savings tax bill surges
Another reason is the UK’s current economic climate. We’ve seen stubborn interest rates refusing to fall more than 1% over the last year. While there have been three cuts, it’s expected only one extra rate reduction might happen in 2025.
Currently rates are at 4.5%, after the last cut in February. With higher savings rates, savers are making more interest, which in turn means higher tax receipts.
A third cut in a year is welcome for our wallets but with inflation having risen back up to 3%, the chance of another rate cut has diminished.
It means savers could still be paying more tax for a while longer – particularly those who have locked in a fixed rate.
What can savers do?
It’s unlikely current Chancellor Rachel Reeves will unfreeze the thresholds anytime soon, especially after confirming they’ll remain frozen in the Autumn Budget. With pressure on the Treasury’s finances, finding ways to raise revenue without breaching a Labour election pledge point all the signs to keeping the freeze.
So, what can savers do to lessen the impact? Here are three ways to help you start making more of your money today.
What’s right for you will depend on your goals. If you’re going to need the money within five years, cash savings options are likely the better choice.
If your goals are for the longer-term, more than five years, investments usually give you a higher return compared to cash savings. Unlike the security offered by cash, with investing nothing is guaranteed and there’s a chance you could get back less than you invest.
Product and tax rules can change, and benefits depend on personal circumstances.
Stocks and Shares ISA
If you don’t need the money within five years, you could consider investing in the stock market through a Stocks and Shares ISA.
It’s generally best to consider investing in one for at least five years. That’s because the longer you invest, the greater the chance that your money will outperform cash.
The best part? Any growth or dividends you earn from your Stocks and Shares ISA are sheltered from UK income tax and capital gains tax. Plus, you can contribute up to £20,000 each tax year as part of the ISA allowance.
You can put money into an ISA and use it to buy shares, funds and other types of investments, with the potential to earn more than just interest in a cash ISA. But remember, because investments can go down in value as well as up, you could lose money.
You can also withdraw from a Stocks and Shares ISA whenever you need to. However, investing should be considered over the long-term and investments must first be sold, meaning your money might not be immediately available.
Top up your pension
If you want to invest for the future, you can top up your pension. It can reduce your taxable income and cut the amount of income tax you pay. For higher earners, the tax perks are even more attractive.
Remember, you can only usually access money in a pension from age 55 (rising to 57 from 2028).
A UK resident under 75, can usually pay up to £60,000 into pensions each tax year and get tax relief from the government. You’ll only get tax relief on personal pension contributions up to 100% of your earnings, or £3,600 – it depends on which is higher.
If you’ve already taken money from your pension, or you’re a high earner, you might have a lower annual allowance.
How much tax relief you get on your pension contributions, depends on which tax bracket you’re in.
Cash ISA
For those wanting to still have cash savings for emergency funds or likely to need the money within five years, a Cash ISA can help.
Like the Stocks and Shares, any interest earned in a Cash ISA is sheltered from UK tax. Plus you can pay in up to £20,000 as part of the annual ISA allowance, across all ISAs.
Cash ISA have become more popular in the last two years, with savers holding a record £390bn by the end of last year. That’s over £50bn more than the start of the year.
While they have drawn some criticism from City financial firms, there’s no sign that Rachel Reeves will make changes to the current Cash ISA structure. For now, they’re just rumours so it’s better for savers to focus on what we do know.
The Cash ISA market has grown, but with so much choice, it can be hard to find great rates.
The HL Cash ISA is one way to do this.
As part of an online savings platform, it brings competitive rates from different banks and building societies into one online account.
The Cash ISA also lets you spread your money across fixed-rate, easy-access, and limited-access products. All offered by different banking partners.
Through one easy-to-use login, you can switch between banks as much as you like when your terms come to an end.
Products can be added or withdrawn at any time.
Take advantage of our special offers. See what’s available for new and existing HL clients. Terms apply.
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