UK Savers Face Double Tax Hit as Interest Rates Soar

The number of UK savers facing taxation on their savings interest is set to double within a two-year period, according to official figures from HM Revenue & Customs (HMRC). This significant increase is primarily attributed to frozen income tax thresholds and elevated interest rates.

By the 2024-25 tax year, over 2 million savers are expected to incur tax bills on their savings, a substantial rise from 1.17 million in the 2022-23 tax year. The impact is particularly pronounced for higher and additional rate taxpayers, with their combined total projected to increase from 630,000 to 1,061,000 over the same period.

The Personal Savings Allowance (PSA), introduced in 2016 by former Chancellor George Osborne, allows basic rate taxpayers to earn up to £1,000 in tax-free interest on their savings. Higher rate taxpayers have a £500 allowance, while additional rate taxpayers receive no allowance. However, the combination of frozen income tax thresholds and high interest rates has led to a sharp increase in the number of savers exceeding their allowance in recent years.

The data, obtained through a Freedom of Information request by broker AJ Bell, reveals that of the 2.07 million people expected to pay tax on their savings this year, 954,000 are basic rate taxpayers. This figure has more than quadrupled from just 226,000 in 2021-22. For higher rate taxpayers, the number paying levies on their savings is expected to more than triple from 158,000 to 590,000 between 2021-22 and 2024-25.

The Conservative government's decision to freeze income tax thresholds from 2020-21 until 2027-28 has effectively resulted in a stealth raid on earnings. As inflation pushes up incomes, millions of people are being dragged into higher tax brackets. The Labour Party has not indicated any plans to alter this timetable.

In response to these changes, savers are increasingly turning to Individual Savings Accounts (ISAs) to shield their money from taxation. ISAs, which allow for £20,000 of tax-free savings annually, have seen a significant influx of funds. According to analysis by Paragon Bank, savers moved an additional £42 billion into cash ISAs during the first six months of 2024.

"Previously the majority of people didn't need to worry about paying tax on their savings, as interest rates were low and the personal savings allowance was sufficient to cover most people. But now a tricky combination of interest rates rising, cash ISAs being shunned for decades, more people moving into higher tax brackets and seeing their personal savings allowance cut, and the tax-free allowance being frozen means lots of people are being dragged into the tax."

Shaun Moore, from wealth manager Quilter, added that due to the actions of the outgoing Conservative government and the likely inertia of the current Labour government, more people will pay higher amounts of tax on their savings interest. He emphasized that the situation is unlikely to change soon, making ISAs increasingly attractive.

This development underscores the importance of understanding the UK's complex tax system, which has evolved significantly since its introduction of progressive income tax in 1799. As the Bank of England's base rate continues to influence savings interest rates, savers must remain vigilant and consider tax-efficient options to maximize their returns.