If you earn less than a total of £18,570 a year from all sources of income, the main ones being PAYE, self-employed earnings, pensions and savings combined, then any interest received from the savings element is potentially tax-free.
This bonus from the Treasury is primarily due to what’s called the ‘starting rate for savings’ which you get on top of your ‘personal savings allowance’. It can be complex, so read on:
First of all, there are three allowances that you need to understand to see how you will be taxed.
- Your personal allowance.This is the amount of income you can receive, whether it’s from work, pensions or savings interest, on which you do not have to pay income tax £12,570 (for 2025/26) or £13,830 if claiming Married Couples Allowance.
- A £5,000 starting rate allowance for savings. If you’re on a lower income you may be eligible for an extra tax-free allowance of up to £5,000 for your savings.
– If your income from pensions or work is under the personal allowance (£12,570), you get the full £5,000, meaning you can earn up to five grand in savings interest without being taxed.
– If your income from pension or work is above the personal allowance (£12,570), you lose £1 of the £5,000 starting rate for savings for each £1 you earn above the personal allowance.
– If your income from pension or work is £17,570 or more. You don’t get any of the £5,000 starting rate for savings.
- A Personal Savings Allowance (PSA). This is worth up to £1,000, which means that everyone who pays basic 20% rate tax (so those who earn more than the £12,570 personal tax allowance but less than the £50,270/year limit for the higher rate of tax) can earn £1,000/year in savings interest before paying any tax on it.
This is added on top of the £5,000 starting savings rate. So, if you’re on a low income, you’re able to earn up to £5,000 savings interest without paying tax but you’ll also pay no tax on the next £1,000 of savings interest – using up your personal savings allowance.
So, by combining the three allowances, it’s possible that some of you can have a total income of up to £18,570 totally tax free…
This is because you get your personal allowance before you start to pay income tax (£12,570), plus the starting rate for savings (up to £5,000) and the personal savings allowance (£1,000) all in combination.
A few practical examples to show how this works in practice…
Ben: Earns £12,000 from work and has £5,000 in savings income
In this scenario, Ben won’t pay any tax at all. His entire income from work is under his personal tax allowance of £12,570, so he’s not taxed on it.
Of his savings, the first £570 of interest is also covered by his personal tax allowance. Then, the remaining £4,430 of interest is covered by the £5,000 starting rate for savings, meaning Ben pays no tax.
Simon: Earns £14,500 from work and has £2,500 of savings income
Simon will pay £386 in tax, all on his income from work. This is because he earns £1,930 more than his personal tax allowance of £12,570. However, all his savings interest will be tax-free, as it’s covered by the starting savings rate.
As Simon earns more than £12,570, his income from work starts to eat in to his £5,000 starting savings rate allowance. He loses £1 of starting savings allowance for every £1 he earns over his personal allowance, so he’s left with £3,070 (£5,000 – £1,930) of his starting savings allowance, which more than covers his £2,500 interest, therefore he doesn’t pay any tax on it.
Clare: No income from work, has £20,000 of savings income
In this scenario, Clare will need to pay tax of just £286. As she has no earned income, the savings interest is mostly covered by a combination of allowances:
- Personal allowance – the first £12,570 is tax-free
- Starting savings rate – the next £5,000 is tax-free, so £17,570 of the interest income is taxed at 0%
- Personal savings allowance – means the next £1,000 is tax-free, so £18,570 is taxed at 0%.
This leaves Clare with £1,430 of savings income which she will need to pay tax on. As she has no other income, this will be charged at the basic 20% rate, so she’ll pay £286 in tax.
Natalie: Earns £35,000 from work, has £5,000 of savings income
Natalie will have to pay a total of £5,286. First, she pays £4,486 income tax at the 20% rate on her earnings from work above her £12,570 personal allowance, plus she will have £800 in tax to pay on her savings interest.
- The first £12,570 of her income from work is tax free, but she’ll pay basic-rate 20% tax on the amount above that.
- Natalie earns more than £17,570, so there’s no starting rate allowance for savings available to her.
- However, as a basic-rate taxpayer, she does get a personal savings allowance of £1,000, which covers £200 of her interest.
- The remaining interest of £4,000 will be taxed at 20%, meaning she’ll pay £800 to HMRC, on top of the tax she pays on her salary
In the last example, Natalie should consider sheltering some or all of her savings in an ISA, legally cutting her tax bill as interest in an ISA’s is earned tax free. Assuming Natalie had the disposable income, she could save up to £20,000 in one account, every tax year, and still be within current HMRC limits.
Accountant’s view
I have been surprised by just how many people I’ve met recently, who did not have the faintest idea how HMRC taxed their savings and the allowances available. So, I hope that today’s Blog has been helpful to some of you and don’t forget to research the many ISA’s available, which could save you even more tax!
