More people are expected to pay tax on their savings due to rising interest rates, experts have warned.
According to a Freedom of Information (FOI) request to HMRC from the financial firm AJ Bell, around 2.7million people are expected to be hit by savings taxes this tax year. This is up from one million the tax office had previously estimated.
AJ Bell says the increase is down to the 14 consecutive base interest rate rises from the Bank of England over the last two years. The latest Bank of England base rate sits at 5.25% - this is significantly higher than the 0.1% level from December 2021.
As interest rates have risen, so have savings rates however, even though this may sound great AJ Bell says this also increases tax bills as more and more people hit their tax free savings limit. According to the firm, higher-rate taxpayers with cash in the best easy-access account in December 2021 could have up to £77,000 before hitting their tax-free limit.
This limit has dropped to £9,525 today and they will pay tax on only £8,265 of cash savings under the current best one-year fix Basic-rate taxpayers could have had £154,000 in the best easy access account two years ago before getting taxed – which has shrunk to just over £19,000 today.
Laura Suter, head of personal finance at AJ Bell, warned that many people - particularly average earnings with emergency savings pots - may be paying tax on their savings for the first time. There is a personal savings allowance which lets you earn a certain amount of interest before you start to pay tax.
The personal savings allowance for 20% basic rate taxpayers is £1,000, and for higher 40% rate tax payers, the allowance is £500. Additional rate taxpayers - so those with a salary higher than £125,140 - receive no tax break at all.
Laura explained when the base interest rate was at 0.1% in December 2021 a basic-rate taxpayer would need to have £1million in cash savings to hit their £1,000 tax-free limit. However, as rates have "shot up" and the allowance has remained "stubbornly still" many will now be caught out. This is due to the frozen Income Tax bands which have seen many Brits pushed into a higher tax bracket.
Laura said: "To add insult to injury, lots of taxpayers will have been pushed into the next tax bracket over the past two years, thanks to frozen income tax bands. This means they will have seen their Personal Savings Allowance cut from £1,000 to £500, if they’ve moved from basic rate to higher rate tax. Or they will have seen the allowance wiped out entirely if they’ve been pushed into the additional rate bracket."
Laura said many Brits may want to take a look at opening a cash ISA to avoid having to pay tax on their savings. A cash ISA is a savings account you don't pay tax. You can put up to £20,000 into ISA accounts each tax year. Although, Laura said savers need to assess what is the best option for them.
She added: "The annual ISA limit of £20,000 is generous, but if you’ve spent years accumulating savings outside of an ISA you might find you hit that limit pretty quickly when you want to transfer your money into the tax efficient account. Cash ISAs also often pay lower interest rates, so savers will need to do their sums to work out whether it’s worth picking a higher paying non-ISA account and paying tax on their savings interest, or putting it in an ISA and accepting a lower rate."