Personal savings allowance
Earn up to £1,000 savings interest tax-free
Less than 5% of people in the UK pay tax on their savings interest due to the personal savings allowance (PSA), which lets most people earn up to £1,000 in interest without paying tax on it. In fact, at current dire savings rates, you'd need to have £200,000 in the top easy-access savings account to exceed the allowance! This guide has full details on the PSA and how it works...
What is the personal savings allowance and what does it mean for my savings?
Your personal savings allowance (PSA) is a tax-free allowance that lets you earn interest on your savings without paying tax on that interest. The allowance you get depends on what rate of income tax you pay:
- Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year with no tax
- Higher-rate (40%) taxpayers: can earn £500 in savings interest per year with no tax
- Additional-rate (45%) taxpayers: £0 – they do not get an allowance.
The estimate is that more than 95% of savers don't pay any tax on their savings interest due to the PSA. See the Treasury's advice on tax on savings interest for more information.
The PSA covers any interest you earn from bank accounts, savings accounts, credit union accounts, building societies, corporate bonds, government bonds and gilts. It also includes interest earned on other currencies (eg, US dollars, euros) held in UK-based savings accounts.
Peer-to-peer lending interest is also covered, but dividend income from shares or funds is not included in the allowance (you have a separate allowance for that). The PSA does include interest distributions (but not dividend distributions) from authorised unit trusts, open-ended investment companies and investment trusts and most types of purchased life annuity payments.
Note for Scottish residents: you pay different rates of income tax, but for the purposes of the personal savings allowance the English tax bands are used – so for 2021/22, most will have the full £1,000 PSA if they earn up to £50,270.
How much do I need in savings before my interest is taxed?
At current low rates, you'd need £10,000s in savings before the PSA even comes in to play. We've looked at how much you'd need in a couple of different savings accounts to hit the PSA thresholds (assuming current best-buy rates):
Do note that any savings over £85,000 held in the same account or with the same banking group won't be protected. See the Are my savings safe? guide for more.
This personal savings allowance is a special vehicle for savings, creating it as a new tax bracket in its own right – within the income tax system.
Yet your personal savings allowance is completely separate from the personal allowance most taxpayers get on their standard income. Under this, the vast majority of people can earn £12,570 before any tax is charged.
To know if you're getting this allowance, find your tax code. If it's not 1257L (or S1257L if you live in Scotland or C1257L if in Wales) then check carefully whether it's correct. Our Tax Code guide can help. Or, to find your current take-home pay, use our income tax calculator.
If you earn less than £17,570, the starting savings rate allows you to earn up to £5,000 in savings interest completely tax-free. This is in addition to your personal income tax allowance and personal savings allowance.
How much of the £5,000 allowance you get depends on how much you earn and can be quite complex – full info in Tax-free savings & the starting savings rate.
In this scenario, the interest earned is assumed to be split down the middle.
The basic-rate taxpayer gets £1,000 of personal savings allowance, and the higher-rate taxpayer £500. So, if we assume interest earned on the joint account is £1,000, the basic-rate payer will still have £500 of their PSA left, but the higher-rate payer's PSA will be used up. If they have other savings, they'll need to pay tax on any further interest.
Having said this, savings on joint bank accounts is more complicated and HMRC suggests in this instance contacting it to report the saving income of interest as appropriate.
Simply, yes. However, the tricky question comes if your non-savings income, which would generally be income from work (whether employed or self-employed), is below the higher-rate threshold but your savings income would take you above it.
So do you get the £1,000 for basic-rate taxpayers or do you get the £500 for higher-rate taxpayers?
To work this out you first must add up your income from work and income from earned savings interest to get your total income. If that total income puts you in the higher-rate band (starts at £50,270 in 2021/22) then you are a higher-rate taxpayer and you only get the £500 of personal savings allowance (similarly for those at the additional-rate threshold – you wouldn't get the personal savings allowance at all).
Let's do an example...
The higher rate of tax starts on income above £50,270 (in the 2021/22 tax year). You earn £50,269 plus have £1,000 in savings interest. As your total income including interest is above the higher-rate threshold you'll only get the £500 personal savings allowance. So, £500 of your interest would be tax-free, while the remaining £500 would be taxed at the higher rate.
For a more detailed exploration of this, see Martin's blog on how the personal savings allowance means some will be better off earning LESS interest.
So, does this mean I don't need a cash ISA?
While it's true to say that interest that's already tax free – eg ISA interest and Premium Bond 'winnings' – isn't included in the interest counted towards your PSA, it doesn't necessarily mean that these products are defunct. Here's Martin's view...
"The main question now is 'what pays the highest rate?'"
For most people the personal savings allowance will mean all of their savings are tax-free, and therefore when choosing a product, the basic question is simply "What pays the highest rate?"
And for most people with under around £20,000 of total savings, cash ISAs won't be a winner. In fact, ISAs can generally be beaten for most people by top easy-access savings.
It's rare, but occasionally the top easy-access cash ISA pays more than the top easy-access savings; in which case even if there's no tax gain, if the rate is higher, use the ISA. Plus the top fixed ISAs allow you to access your cash early for a small interest penalty while the top fixed savings don't – so there can be other reasons ISAs win; for nerdy detail on this, see Is the cash ISA dead?.
For bigger savers and higher earners a cash ISA is still a winner
The most important thing to note is that cash ISA interest doesn't count towards your PSA, so you can earn it tax-free – and still have your full £1,000 (or £500) PSA allowance. Therefore for top-rate taxpayers or bigger savers who've used up the PSA, there are big tax advantages of saving in a cash ISA.
- Basic-rate taxpayers over the PSA limit. For every £100 interest you earn in normal savings you only get £80, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 25% higher for it to beat a cash ISA.
- Higher-rate taxpayers over the PSA limit. For every £100 interest you earn in normal savings you only get £60, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 66% higher for it to beat a cash ISA.
- Top-rate taxpayers. For every £100 interest you earn in normal savings you only get £55, whereas in an ISA you get all the £100. Therefore the normal savings rate would have to be 82% higher for it to beat a cash ISA.
So cash ISAs can be winners even with lower rates.
Also it's worth remembering that while £1,000 a year interest seems a lot now with our current pitiful interest rates, if interest rates rise then more people will need to pay tax. So saving into an ISA now could protect you from future tax.
I'm in the 5% who do owe tax - how to I pay it?
Your bank or building society will pay all savings interest due to you gross (without tax taken off the amount).
HM Revenue & Customs says any tax owing will be paid through changes to your tax code. So you'll get a lower personal allowance for income tax to pay any tax due on savings interest. HMRC will look at how much you got in saving interest last year and base your tax code next year on that if you went over your personal savings allowance. Those who self-assess will continue to pay through that system.
If you've had a tax code change in the past and are now earning less interest than your PSA, you'll need to contact HMRC as it will need to adjust your 2021/22 tax code to be correct.
You can call it on 0300 200 3300 or go online to your personal tax account – go to 'check your income tax' and then 'tell us about a change'.
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