How the personal savings allowance works

Introduced in 2016, the personal savings allowance means most people can earn a certain amount of tax-free savings interest. In this article, we look at how the personal savings allowance works and what happens when you exceed it. We also consider the implications for tax-free savings accounts, such as ISAs.

The personal savings allowance (PSA) lets you earn a certain amount of interest on your savings without paying tax. How much you can earn in tax-free interest will depend on whether you are a basic rate, higher rate or additional rate taxpayer:

• Basic rate taxpayers can earn up to £1,000 in interest on their savings
• Higher rate taxpayers can earn up to £500 in interest on their savings
• Additional rate taxpayers do not receive a personal savings allowance.

The tax bands that apply to England, Wales and Northern Ireland are used to determine the personal savings allowance (the income tax bands and rates are slightly different for Scottish residents).

Low earners with a total taxable income of less than £17,570 in 2023/24 are eligible for the starting savings rate. The starting savings rate is a special 0% tax rate on interest up to £5,000. It is reduced for every £1 you earn over your personal income tax allowance, which is set at £12,570 in the 2023/24 tax year.

While lots of people won’t pay tax on their savings interest, recent interest rate rises could mean there’s a risk that more savers will exceed their PSA.

If you are a basic rate taxpayer with a competitive easy access savings account paying 3.4% AER, you would currently need just over £29,412 in savings to exceed your PSA. Higher rate taxpayers with the same account start paying tax on their interest if they have around £14,700 in savings.. If this applies to you, you may want to consider utilising tax-free savings options like ISAs (more on this later).

If you own a joint account with someone else, interest is usually split equally between you and the other account holder. 

The PSA applies to any interest earned from the following:

• Bank and building society accounts
• Savings and credit union accounts
• Unit trusts, investment trusts and open-ended investment companies
• Peer-to-peer lending
• Trust funds
• Payment protection insurance (PPI)
• Government or company bonds
• Life annuity payments
• Some life insurance contracts.

Crucially, it does not apply to interest earned from tax-free savings accounts such as ISAs or some National Savings & Investments products. 

A separate tax-free dividend allowance applies to dividend income from shares or funds. Different rules also apply to interest earned on children’s accounts and foreign savings.

Any interest that exceeds your PSA will be taxed at your usual rate of income tax. So, if you’re a basic rate taxpayer and you exceed the £1,000 allowance, you’ll be taxed 20% on any interest earned after that. 

Higher rate taxpayers will be taxed 40% on interest that exceeds their £500 PSA. As additional rate taxpayers are not entitled to a PSA, all interest earned on their savings is taxed at 45%.

Thanks to recent increases in interest rates over the last year or so, more people could find themselves exceeding their personal savings allowance. This is one of the reasons why it’s important to keep your savings strategy under review.

Any interest you earn from your savings will be paid to you in full by your bank or building society. If you’re employed or receive a pension, HMRC will claim back the tax by automatically adjusting your tax code. They will review how much interest you earned in the previous tax year to determine your new tax code.

If you’re self-employed, you’ll need to report any interest earned on your annual Self Assessment return.

If you think you’ve paid too much tax on your savings income, you can claim a refund by completing form R40 or applying online. You must do this within four years of the end of the relevant tax year.

You can currently save up to £20,000 per tax year in an ISA and any interest will always be tax-free. But for many people, historically low interest rates and the introduction of the personal savings allowance means ISAs are not as appealing as they once were. That said, they can play an important role in your overall savings and investment portfolio, especially if you aren’t entitled to the PSA or your savings have reached a level where they could trigger a tax charge.

If your savings income is unlikely to exceed your PSA, it makes sense to consider non-ISA savings products. That’s because the top-paying traditional savings accounts tend to offer more competitive interest rates than most ISAs. You can quickly and easily compare competitive savings accounts by visiting the table at the top of this page.

However, if you’re a basic rate taxpayer with substantial savings or you’re a high earner, ISAs can be very useful. Savings in an ISA don’t count towards your PSA, so if you’ve used up your £1,000 or £500 allowance, an ISA can still provide you with a tax-free way to save. Likewise, if you aren’t entitled to the PSA because you’re an additional rate taxpayer, an ISA can help to minimise tax and boost your return.

It’s worth bearing in mind that if interest rates rise, your chances of exceeding your PSA will also increase, particularly if you are a higher rate taxpayer with a reduced PSA. In this case, it may be worth choosing a combination of high-interest savings accounts and ISAs. 

Before taking action, it’s important to compare all the different types of savings accounts you’re eligible for, so you can find the one that’s right for you and your savings goals. 

Saving money with Raisin UK is simple. All you need to do is register for a Raisin UK Account and choose your preferred partner bank to open an account with. 

Some of the most popular types of savings accounts include fixed rate bonds, easy access accounts and notice accounts.

• Fixed rate bonds – these may be a good option if you have a lump sum of money as you can lock it away for a set period and earn a competitive rate of interest in return. 
• Easy access savings accounts – if you’re looking for more flexibility, easy access savings accounts allow you to withdraw money whenever you like. However, they tend to offer lower rates of interest. 
• Notice accounts – these types of accounts combine the benefits of both fixed rate bonds and easy access accounts. They give you a degree of flexibility in that you only need to give a short notice period to access your savings (typically between 30 and 90 days). Plus, they also provide competitive rates of interest.