Frozen Savings Allowance Forcing Millions of UK Savers to Pay Tax

Brits are used to stashing their cash in savings accounts without worrying about the taxman taking a cut. But now thanks to higher interest rates than years ago and a frozen personal savings allowance (PSA), more than a million extra savers are being dragged into an unexpected tax trap, data shows.

Many won’t see it coming until a brown envelope from HMRC lands on their doormat with a thud. So, what is happening and why is this happening now? Let’s take a deep dive.

Why More Savers Are Getting Taxed

HMRC has been sending out letters to taxpayers warning them they owe tax on their savings interest. It’s an annual routine, in that the tax office cross-checks data from banks and building societies to see who’s earned enough interest to trigger a bill. And this year the numbers are rocketing.

Latest figures show 1.17 million taxpayers were stung by income tax on savings for the 2022/23 tax year. Of these, 505,000 were basic-rate taxpayers who breached their £1,000 tax-free PSA, whereas 344,000 higher-rate earners surpassed their £500 allowance.

It’s only getting worse. A Freedom of Information request by investment platform AJ Bell found 2.07 million people will be slapped with savings tax in 2024/25, a big jump from only 650,000 three years ago.

The Frozen Savings Allowance Squeeze

The trigger: the PSA hasn’t budged since it was introduced in 2016. If it had kept up with inflation, basic-rate taxpayers would now have a £1,360 allowance, and higher earners would get £681. Instead much to the horror of taxpayers, thresholds is stuck at £1,000 and £500 as elevated interest rates kick more savers past the limit.

For top earners (those making more than £125,140 and paying the 45% additional rate), the situation is even crueller: that they get no PSA at all, meaning every penny of savings interest is taxable.

Many people won’t realise they owe anything until HMRC adjusts their tax code, quietly slashing their take-home pay. Although self-assessment filers declare savings interest, PAYE taxpayers rely on HMRC’s calculations, which often provoke a shock when their tax code changes.

In other words, you might not get a direct bill; instead, the tax is clawed back gradually from your salary, leaving you with less in your pocket each month.

A System Under Strain

When George Osborne introduced the PSA in 2015, interest rates were near zero, and the allowances seemed generous. At the time, experts said only the wealthiest would be affected, yet millions of ordinary savers are being caught out.

With the government considering an ISA overhaul, uncertainty looms over how savings will be taxed in the future.

What Can Savers Do?

Before the taxman comes knocking, you should do the following.

• Check Your Interest – If you’ve earned more than £1,000 (or £500 as a higher earner) in savings interest, you’ll likely owe tax.
• Use ISAs – Cash ISAs are tax-free, so funnelling savings there can shield you from future bills.
• Act Fast if HMRC Contacts You – The tax office warns if you haven’t received a letter but think you owe tax, you should get in touch "as soon as possible to avoid a penalty".

Conclusion

What was once a quiet corner of personal finance has now become a surprising tax trap for millions. Given that interest rates are high (versus a few years ago) and the personal savings allowance stuck in time, even modest savers are coming into sharper focus in HMRC’s sights.

True, the government has yet to provide some form of relief, but savers can take steps to protect themselves, starting with awareness. A little attention today can prevent an unpleasant tax hangover tomorrow.