What are tax-free savings accounts?

Tax-free savings accounts can be a good option for lower-income earners who don’t yet have any savings or want to grow the money they’ve already got. On this page, you’ll learn what a tax-free savings account is, how tax-free savings work and who’s eligible, what the starting savings rate is, plus the pros and cons of tax-free savings accounts.

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The rundown
  • A tax-free savings account lets you earn interest on your savings without paying tax
  • You can enjoy tax-free savings if you either earn less than £18,500 a year or set up an ISA, which will allow you to save up to £20,000 per year tax-free 
  • You can only save up to £20,000 cash tax-free, regardless of how many ISAs you open

What is a tax-free savings account?

A tax-free savings account is a type of savings account that lets you earn interest on your savings without paying tax on the interest you earn. There are typically restrictions on this type of account, such as your annual income and how much you can save each year (more on that below).

How do tax-free savings work?

In the UK, tax-free savings accounts allow you to earn interest tax-free if your annual income and savings interest is less than £18,500 in total. 

In addition to dedicated tax-free savings accounts, you could also take advantage of a personal savings allowance (PSA) that allows you to earn up to certain amounts tax-free depending on your tax-banding.

Individual Savings Accounts (ISAs) explained

ISAs, or individual savings accounts, are another type of tax-free savings account that anyone can apply for. With an ISA, you can save up to a maximum of £20,000 per tax year (normally 6th April to 5th April), and you can choose from a few different types of ISA, including cash ISAs and stocks and shares ISAs.

You can pay all of your tax-free savings allowance of £20,000 into your ISA(s), meaning you won’t pay income tax on the interest or dividends you might earn from your ISA. You also won’t pay capital gains tax on the profit you make from your savings.

What’s the starting savings rate?

You may have heard of the starting savings rate, which was created to help low-income earners on £17,500 per year or less save. The starting savings rate is a special 0% rate of tax on interest up to £5,000 (applicable to the 2020/21 tax year). This means you can earn up to £5,000 interest in your savings accounts completely tax-free.

Are there limits on tax-free savings?

Yes, tax-free savings accounts do come with some limits. Low-income earners who earn up to £17,500 a year are eligible for the starting savings rate. This includes your total personal allowance of £12,500, which is the amount you can earn before paying tax, plus the starting rate of £5,000. 

As previously mentioned, the PSA allows anyone to earn a certain amount of money from their savings without paying tax, depending on their savings earnings and tax-banding. If you’re a basic-rate taxpayer, you can earn up to £1,000 in savings interest per year without paying tax on that interest, and higher-rate taxpayers can earn up to £500. This will increase your tax-free savings limit to £18,500, which includes your personal allowance (£12,500), starting savings rate (£5,000) and your personal savings allowance of £1,000. 

There are some exemptions and differences, depending on your personal circumstances. For example, if you have a blind person’s allowance, your limit could be increased to £20,950. You might also be eligible for the married couple’s allowance.

What are the pros and cons of tax-free savings?

The main benefit of a tax-free savings account is, of course, that you won’t pay tax on the interest you earn from your savings. You’re also free to make withdrawals without incurring any penalties.

However, tax-free savings accounts in the UK typically offer less competitive interest rates than traditional savings accounts, and you could utilise your PSA to earn money from your savings without having to pay tax. It’s important to compare all the different types of savings accounts you’re eligible for, so you find the one that’s right for you and suits your savings goals.

Are there any better alternatives to tax-free savings accounts?

The alternatives to tax-free savings accounts are traditional savings accounts, such as easy access savings accounts, notice savings accounts and fixed rate bonds

While there’s a possibility you may have to pay tax on your savings, it’s unlikely unless you earn between £500 and £1,000 in interest, depending on your tax bracket, and you’ll typically benefit from higher interest rates. It’s always important to compare savings accounts, so you get the right type of account with the best interest rate for you.

Can I have two tax-free savings accounts?

In the UK, you can open up to four ISAs, meaning you could split your £20,000 allowance over those accounts. You cannot save £20,000 tax-free in each ISA. Providing you are aged 18 or over, you can open the following types of ISA: 

Open a savings account through our marketplace

While we don’t offer tax-free savings accounts through our marketplace, you can choose from a range of competitive savings accounts from our partner banks. Simply register for a Raisin UK Account to quickly and easily apply for free.

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