Interest Rates and Personal Savings Allowance

In August 2023 the Bank of England raised the UK's interest rate to 5.25% in its ongoing efforts to curb surging prices. This was the 14th consecutive rate rise, and the first time that the base rate has reached this level since April 2008 [1].

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As a result, we are currently experiencing higher interest rates on our cash savings than we have seen in 15 years.

Although interest rates are still below the current rate of inflation - the Consumer Price Index (CPI) stood at 6.7% in August 2023 [2] - those with cash savings are now seeing a greater return on their money.

Unexpected Tax Charges

Whist this is positive news, those holding larger cash funds may unexpectedly exceed their Personal Savings Allowance (PSA) and find that they need to pay tax on the interest earned.

The PSA allows you to earn the following amounts of savings interest tax free:

  • Basic rate taxpayers can earn up to £1,000

  • Higher rate taxpayers can earn up to £500

  • Additional rate taxpayers have no tax-free allowance

Any savings income which exceeds these levels is taxable. This can affect your overall tax liability and may require you to adjust your tax planning.

If you complete a self-assessment tax return you will need to declare your savings interest and pay and subsequent tax due. 

If you are taxed under Pay As You Earn (PAYE), HMRC will calculate any tax due based on information sent to them by banks and building societies. HMRC will adjust your tax code accordingly, which means that many taxpayers will see an impact in their payslip each month.

Alternative Solutions

Having sufficient funds in cash is an important part of any financial plan, particularly as a buffer for emergencies and to pay for known expenses. However, holding too much in cash can be detrimental as you are not giving your funds the chance to outperform inflation and as we have shown above, you could be paying more in tax than you need to.

There are some simple measures that you can take to help mitigate the amount of tax you pay, such as:

ISAs (Individual Savings Accounts): ISAs offer a tax-efficient way to save or invest money. Interest earned within an ISA is typically tax-free. You can choose between a Cash ISA and a Stocks and Shares ISA, depending on your savings and investment goals.

Premium Bonds: Prizes won in Premium Bonds are tax-free.

Depending on your personal situation and risk appetite, adding funds to your pension or other investment options may be appropriate.

If you hold significant cash savings, particularly if you are in line for an unexpected tax charge, it may be beneficial to speak to a certified Wealth Planner to understand how higher interest rates might affect your specific financial situation and to consider alternative solutions with the potential for increased returns on your savings.

[1] 10/10/2023 | Bank Rate history and data| Bank of England Database

[2] 10/10/2023 | Inflation and prices indices|

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment(s) and the income derived from it, can go down as well as up and you may not get back the full amount you invested.

This information is based on our current understanding of taxation legislation and regulations.  Any levels and bases of, and reliefs from, taxation are subject to change and tax implications will be based on your individual circumstances.

Please note, The Financial Conduct Authority does not regulate advice on taxation.