Savings and tax
The Personal Savings Allowance hasn't moved since 2016. Everything around it has.
A while ago I sat down to work out whether one savings account was actually better than another. I had a lump sum I needed to keep fairly accessible, so I wanted a cash account with the best rate.
I realised I didn't need the best headline rate. I needed to work out the number I'd end up with after tax. It took longer than it should have to calculate, despite the fact I've spent over a decade in financial services.
One of the factors to calculate is your available allowance.
So what is the allowance?
The Personal Savings Allowance (PSA) lets you earn some interest each year without paying tax on it. How much depends on your tax band:
- Basic rate: £1,000
- Higher rate: £500
- Additional rate: nothing at all
It arrived in April 2016 and hasn't changed since. Over a decade ago!
Think about how much the world has changed since then. Or even just the UK financial landscape. When the PSA launched, the Bank of England base rate was 0.5%, and it fell to 0.25% four months later. Today it's 3.75%. The allowance was set for a low-rate world and has been frozen while the rates around it climbed.
Let's quantify it
At 4.5%, a higher-rate taxpayer uses up the entire £500 allowance at around £11,000 of savings.
Eleven thousand pounds. That's a modest emergency fund, not what most people would call a large sum.
Basic-rate taxpayers get more room, around £22,000 at the same rate. Additional-rate taxpayers have no allowance to use up at all, so the first pound of interest is taxable.
£20,000 at 4.5% earns £900 in a year.
A higher-rate taxpayer keeps £740 of that. An additional-rate taxpayer keeps £495.
Same account, same rate. The difference in what you keep is your tax band.
And it's about to get slightly worse
From April 2027, savings interest gets its own set of tax rates, two percentage points above the standard ones: 22%, 42% and 47%.
Separately, the cash ISA allowance drops from £20,000 to £12,000 for anyone under 65. The overall £20,000 ISA allowance isn't changing, but £8,000 of it can then only be used for stocks and shares. If you're over 65, you can keep the full £20,000 in cash.
Neither of these is a massive deal on its own. Together they mean the gap between the rate you're quoted and the return you actually keep is widening, and the tax-free space you could use to close it is narrowing.
So what can you do?
A couple of things that are useful to know.
ISA allowance doesn't roll over. If your interest is past your allowance, a cash ISA is worth considering even at a slightly lower headline rate, because unused ISA space is gone at the end of the tax year. If you're under your allowance, that argument is much weaker: your interest is already tax-free, so a lower rate is just a lower rate.
Whose name is the cash in? If you're married or in a civil partnership, two people equals two allowances, and if one of you is in a lower band then the difference on the same balance can be meaningful.
And it's always worth working out roughly where your interest lands against your allowance, so there are no surprises.