Personal finance expert Martin Lewis has highlighted key thresholds for savings interest, explaining when individuals may start paying tax on their earnings.
Speaking on his BBC podcast, he addressed common misconceptions about how savings are taxed, emphasising that while the principal amount remains untaxed, the interest it generates can be subject to taxation if it surpasses specific limits.
According to DevonLive, these thresholds vary depending on a person’s income level and tax bracket, meaning many savers may be unaware of their potential tax liabilities.
Understanding the Tax-Free Savings Thresholds
Lewis explained that tax on savings interest depends on income levels and specific allowances. The general personal tax allowance is £12,570, meaning individuals can earn up to this amount from any source—including interest—without paying tax. Beyond this, there are additional allowances specifically for savings interest:
- Basic rate taxpayers (20%) can earn up to £1,000 in savings interest tax-free.
- Higher rate taxpayers (40%) have a reduced allowance of £500.
- Additional rate taxpayers (45%), earning over £125,140, receive no tax-free savings interest allowance.
With interest rates currently at around 5%, a basic rate taxpayer with £20,000 in savings would generate £1,000 in interest, which is tax-free. A higher rate taxpayer would hit their £500 limit with £10,000 in savings. Beyond these thresholds, individuals start paying tax on any additional interest earned.
The Little-Known Starting Savings Allowance
For low earners, there is an additional tax break called the starting savings allowance, which applies to those with an earned income below £12,570. This allowance enables individuals to earn up to £5,000 in savings interest tax-free, in addition to their standard tax-free allowances.
However, for every £1 earned over £12,570, the starting savings allowance decreases by the same amount. For instance, someone earning £13,570 would see their tax-free savings interest reduced to £4,000.
In cases where all income comes solely from savings interest, an individual could earn up to £18,570 tax-free by combining the £12,570 personal allowance, the £5,000 starting savings allowance, and the £1,000 savings interest allowance available to basic rate taxpayers.
To avoid paying tax on savings interest, Martin Lewis recommended using an Individual Savings Account (ISA), where up to £20,000 per year can be deposited tax-free. He also mentioned Premium Bonds, which allow individuals to save up to £50,000 with tax-free winnings.
Is tax on savings a form of double taxation?
Some savers feel that taxing savings interest amounts to double taxation, as the money was initially earned as income and taxed before being saved. BBC presenter Adrian Chiles raised this concern during the podcast:
“Christina’s fed up—she’s sick of working hard, getting taxed on income, and then taxed on savings. How does that work? So frustrating.”
Lewis responded by clarifying the distinction:
“Well, forgive me, but you are not taxed on savings. You do not pay tax on your savings. You pay tax on the interest earned on savings. And I know it is a fine difference, but it is an important one.”
Addressing claims of double taxation, Martin Lewis explained :
“Let’s be technical, it’s not—there are other things that are double taxation. But you get taxed on the amount of money you earn on your income, and then you get taxed on the amount of money you earn on your savings. You do not get taxed on your savings.”
With interest rates fluctuating, savers should be aware of how their earnings affect tax liabilities. By using ISAs, Premium Bonds, and other tax-free accounts, they can reduce their exposure to taxation and maximise their savings returns.
