Basic rate taxpayers can earn up to £1,000 in savings interest completely tax-free – yet many people don’t realise this valuable allowance exists.
Your tax-free threshold depends entirely on your income bracket. Higher rate taxpayers (40%) can claim just £500 tax-free, whilst additional rate taxpayers receive no tax-free savings allowance whatsoever.
These allowances matter for your financial planning. For the 2025/26 tax year, individuals with total taxable income under £18,570 generally won’t owe any tax on their savings income.
The system works by combining your personal allowance (£12,570 for 2025/26) with the starting rate limit for savings (£5,000) and the tax free savings allowance.
Understanding how tax applies to your savings interest helps you make better financial decisions. Know your tax bracket and allowances – this knowledge directly impacts how much you keep from your interest earnings.
Understanding Tax on Savings Interest
Your actual savings don’t get taxed – the interest earned on those savings might be subject to tax.
HMRC defines interest as “the return or compensation for the use or retention by one person of a sum of money belonging to or owed to another”.
Taxable interest covers earnings from bank accounts, building society accounts, credit unions, corporate bonds, government bonds, peer-to-peer lending, and even some life annuity payments.
This also applies to interest from accounts held in other currencies within the UK.
You can earn a certain amount of interest tax-free through three key allowances:
- Personal Allowance – the amount you can earn before paying income tax (£12,570 for most people in 2025/26).
- Starting Rate for Savings – up to £5,000 extra tax-free allowance for those with lower incomes.
- Personal Savings Allowance (PSA) – allows basic rate taxpayers to earn £1,000 interest tax-free, higher rate taxpayers £500, whilst additional rate taxpayers receive no PSA.
ISAs work differently – they’re “tax wrappers” where all interest earned stays completely tax-free regardless of how much you save.
ISA interest doesn’t count towards your PSA either, giving you additional tax-free earning capacity.
Interest becomes taxable in the tax year it’s credited to your account and becomes accessible.
How Tax is Calculated Based on Income
Your overall income level determines how much tax you’ll pay on savings interest. Which tax bracket you fall into directly affects your available tax-free allowances.
Individuals earning less than £12,570 can use their entire personal allowance for savings interest if they haven’t already used it for wages or pension.
Those earning under £17,570 may also benefit from the starting rate for savings, which decreases by £1 for every £1 earned above your personal allowance.
- Basic rate taxpayers (£12,570-£50,270) receive a £1,000 personal savings allowance.
- Higher rate taxpayers (£50,271-£125,140) receive £500.
- Whilst additional rate taxpayers (over £125,140) get no allowance.
Low-income earners can potentially enjoy up to £18,570 tax-free – this combines the:
- £12,570 personal allowance.
- £5,000 starting rate for savings.
- and £1,000 personal savings allowance.
HMRC applies specific rates when calculating tax owed: 20% for basic taxpayers, 40% for higher rate taxpayers, and 45% for additional rate taxpayers on any interest exceeding these allowances.
How HMRC Collects and Processes Tax
Banks and building societies report your savings interest directly to HMRC at the end of each tax year.
HMRC uses this information to determine how much tax you owe on any interest exceeding your allowances.
How HMRC collects this tax depends on your circumstances:
- If you’re employed or receive a pension: HMRC adjusts your tax code to collect tax automatically through PAYE. They estimate your interest based on what you earned last year. This reduces your tax-free personal allowance to reflect the tax owed.
- If you’re self-employed: You’ll report interest on your Self Assessment tax return.
- If neither applies: HMRC will contact you with payment arrangements.
Joint accounts work differently. Spouses and civil partners are typically taxed on 50% of the interest each, regardless of who contributed the funds.
You may elect to be taxed according to actual beneficial interests using form 17 if your shares are unequal.
Overpaid tax can be reclaimed within four years using form R40 or through Self Assessment.
If you don’t receive a tax calculation letter by 31 March following the tax year but believe you owe tax, you should contact HMRC for a review.
HMRC can adjust your tax code at any time throughout the year, not just in April. Check your payslips regularly for unexpected changes.
Conclusion
HMRC tracks your interest through bank reports and adjusts your tax code automatically if you’re employed.
Check your payslips regularly for these adjustments to avoid surprises. Self-employed taxpayers must report interest through self assessment to stay compliant.
Smart planning around these allowances can significantly reduce your tax burden. Use your allowances strategically, consider ISAs for larger amounts, and keep track of how HMRC processes your tax.
These steps ensure you comply with regulations while keeping more of what you earn.
The key lies in understanding your position and acting accordingly. Whether you’re just starting to save or managing substantial interest income, these rules provide clear guidance for keeping your savings tax-efficient.
