Savings warning as millions more to be dragged into ‘tax trap’ this year

Rising interest rates and frozen thresholds are estimated to push another one million people into a “little-known tax trap” this year.

According to data obtained by investment platform AJ Bell, over 2.7 million people will pay tax on their savings interest in 2023/24, up by a million in a single year.

The total includes nearly 1.4 million basic rate taxpayers, a figure which has quadrupled in just four years.

Laura Suter, head of personal finance at AJ Bell said: “These figures highlight just how many taxpayers are facing a tax bill for their savings interest this year – a huge leap when compared to last year.

“The combination of higher interest rates and people having shunned ISA accounts in recent years means that the number paying tax on their savings has more than tripled in the past four years.”

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Ms Suter added: “Rising rates and a frozen Personal Savings Allowance means some individuals are being taxed despite having relatively modest pots of cash set aside for a rainy day. To add insult to injury, because inflation is so high, they aren’t even making a real return on their money – yet they are still being taxed.”

People pay tax on interest earned on any cash savings that exceed the Personal Savings Allowance. For basic rate taxpayers, this currently stands at £1,000 and for higher rate taxpayers, it’s £500.

Additional rate taxpayers, however, get no exemption and have to pay tax on all cash interest they receive.

These tax bills are typically settled through the self-assessment process or deducted from income through a tax code adjustment. Although, AJ Bell pointed out that many may not realise they owe tax until they receive a letter from HMRC indicating a change in their tax code will appear on their next payslip.

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The experts noted that tax hit will exacerbate the issue of cash savings losing value in real terms while inflation remains high.

However, there are ways people can legitimately shield more of their wealth from the taxman and that’s through utilising tax-efficient savings tools and allowances.

Adam Thrower, head of savings at Shawbrook said savers need to be paying attention, not just to the rate, but also to the type of account. He explained: “ISAs are a great way of reducing your tax burden – although they do often come at a slightly lower interest rate.

“Many providers offer ISAs which you can use to save up to £20,000 tax-free per tax year. You can also transfer existing ISA deposits into a new account without it counting towards your yearly allowance providing you keep the money within the ISA wrapper by using the Cash ISA Transfer Service.”

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NS&I Premium Bonds also offer a secure way of storing cash without having to pay tax on interest.

Ms Suter said: “Rather than a set interest rate, prizes of £25 to £1million are paid monthly. The big perk is that any prizes are free of tax. However, the return on Premium Bonds is not guaranteed and you might never win a prize, so anyone choosing this option needs to be prepared to make no return on their money.”

For some households, it may be beneficial to divide savings between a couple. Ms Suter said that if a partner has an unused Personal Savings Allowance, cash could be held in their name instead.

She added: “The same applies if they have an unused ISA allowance. Equally, if one-half of the couple is a lower taxpayer, it might make sense for them to have the bulk of the savings so you pay a lower tax rate on the savings interest.”

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