Tax income on UK savings may soon match inheritance tax

With interest rates on cash increasing to levels not seen in over a decade, it’s little wonder that more people are being dragged above the tax-free threshold, known as the personal savings allowance (PSA). In fact, it’s been reported that the number of people paying tax on their savings income in 2022/23 tax year has almost doubled to 1.77 million compared to the 0.97 million people in the 2021/22 tax year. The amount collected has more than doubled from £1.2 billion to £3.4 billion.

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In the same period Inheritance tax (IHT) intake hit a record breaking £7.1 billion, Although more than double the amount collected in savings tax for the same period, according to freedom of information figures which were exclusively revealed in the Mail on Sunday, savers are expected to owe £6.6 billion on their interest for the current tax year.

One of the reasons for this is last tax years figures don’t take into account that even more people will lose their personal savings allowance this year, due to the Government reducing the additional rate threshold from 6th April 2023, so those earning £125,000 now lose their PSA completely (previously you had to earn £150,000 before losing your allowance).

What is the Personal Savings Allowance (PSA)?

The PSA is a tax-free allowance that lets you earn interest on your savings without paying tax on interest. The allowance you get depends on what rate of income tax you pay.

What are the incomes tax rates for Personal Savings Allowance?

• Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year before paying tax
• Higher-rate (40%) taxpayers: can earn £500 in savings interest per year before paying tax
• Additional-rate (45%) taxpayers: £0 – they do not get an allowance.

Savers breach the personal savings allowance with just £16k saved

Many more people are now getting pulled past the tax-free threshold and are therefore paying tax when they wouldn’t have been even close to the threshold only a few years ago. Looking back, at its lowest point in April 2021, the top 1-year fixed rate bond was paying just 0.58%. This means that you would have needed a deposit of £172,414 in order to earn enough savings income to breach the allowance and therefore pay tax on your savings. By comparison the current top 1-year bond is paying 6.05% gross/AER. A basic rate taxpayer would therefore need just £16,529 in a bond before they breach the threshold and would need to pay tax.

The bottom line

At the end of the day savings rates are well up on where they once were, with little sign of coming back down to levels seen just a few years ago, which means the average person will be making significantly more in savings returns relatively speaking than they once were. Great news of course. However, the caveat of this is that many will breach their PSA much quicker, and therefore the Government takes home an abnormally high volume of tax on savings compared to the much smaller, less valuable amounts gathered in the past.

With estimates that the Government might scrap IHT in the lead up to the next general election, it seems like a win-win for the taxpayer. However, with the amount levied from savings set to potentially match or could even surpass the amount generated from IHT, in real terms the taxpayer would still be getting taxed, and the Government's coffers remain unscathed. 

Added to this the percentage of people who pay IHT is estimated to only be around 5%, so the average saver would be unlikely to have paid any IHT anyway. Savings tax replacing inheritance tax only really benefits those that are already wealthy, with the average saver getting hit by a tax they otherwise wouldn’t have. At the end of the day, the Government is walking away with more tax than before, and the average taxpayer is paying more tax. 

With interest rates at the highest they’ve been in years, it’s more important than ever to seek professional advice to help navigate your personal allowance threshold effectively. Give us a call on 0333 323 9065 or book a free non-committal initial consultation with a member of our team to find out more.

*Sources: Bloomberg; This is money.

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The Financial Conduct Authority (FCA) does not regulate estate planning or tax advice.

The rates mentioned in this article are accurate and correct as of 04/08/2023.