Remember the personal savings allowance? Come on, cast your minds back!
Though I wouldn’t be surprised if it’s a struggle. Most of us haven’t had to worry about paying tax on interest income for ages.
A decade of ultra-low rates relegated fussing over how much we earned in interest into the same category as fretting over Bigfoot.
The personal savings allowance
All that’s changed with rising interest rates, however. Which in turn means the personal savings allowance is making a Mariah Carey-style comeback.
Higher interest rates mean you can now earn much more interest for your money on deposit. And that will mean more savers having to share their spoils with the taxman.
As a reminder, under the personal savings allowance:
- Basic-rate taxpayers can earn £1,000 per year in savings interest without having to pay tax.
- Higher-rate taxpayers can earn £500 per year.
- Additional rate taxpayers don’t get any personal savings allowance.
When rates were low, these allowances seemed quite generous. But rising rates change everything.
They mean that many of us will need to redo our sums.
For my part, though I’ve plucked up the courage to invest more in the stock market in recent years, I still maintain a rainy day savings account for short-notice access to cash.
I regularly contribute to this account and have thankfully have never had to dip into it. Partly because I’m frugal, but also because I’ve fortunately never suffered the hit to my income that my cash savings are earmarked against.
My savings pot has therefore steadily grown bigger, thanks to a stream of regular top-ups.
Of course, increasing the value of the pot in real (inflation-adjusted) terms has been pretty much impossible. And you don’t need to be Einstein to understand why.
When you’re getting no interest on your cash, even low inflation erodes your pot’s real terms value.
But times have changed. The Bank of England has been hiking rates to fight surging inflation – and that’s dragged up interest rates on savings, too.
Savings and inflation
UK inflation just hit 11.1%. That’s the highest level inflation has been at in over 40 years. And it’s been hot throughout 2022.
In response, the Bank of England has hiked its base Bank Rate every six weeks or so.
Only a year ago Bank Rate was a puny 0.1%.
Today it’s 3%.
Okay, so 3% is still a bit ‘meh’, historically. But the rise represents a massive change of direction.
Money is no longer cheap. Savings rates have shot up, as banks are competing for our money again.
This time last year:
- The market-leading easy-access savings account paid 0.66%1 variable.
- The top one-year fixed account paid a pitiful 1.35%.
Fast-forward 12 months:
- The top easy-access deal now pays 2.6% variable.
- The best one-year fix pays 4.36%.
That’s a colossal difference.
Yet before you crack out the champagne, it’s worth remembering even these higher savings interest rates are still well below the level of inflation.
It’s impossible to keep pace with inflation at the moment with cash, but at least looking to have your money in the best accounts helps soften the blow.
Higher interest rates and the personal savings allowance
While tax on savings interest isn’t anything new, the personal savings allowance is very much back in the spotlight thanks to these soaring rates.
For example, last years’ market-leading easy-access savings rate of 0.66% meant a basic-rate taxpayer needed to have roughly £152,000 saved in such an account before they breached their £1,000 savings allowance.
Even higher-rate taxpayers would have needed more than £75,000 stashed away.
With higher rates, however, far less is required to exceed the annual allowance.
Today basic-rate taxpayers need only £38,500-ish in the top easy-access account to breach their personal savings allowance on the interest they will earn.
Higher-rate payers will hit the buffer around the £19,000 mark.
| November 2021 Top easy-access savings: 0.66% |
November 2022 Top easy-access savings: 2.6% |
|
| Threshold: basic-rate taxpayer | £152,000 | £38,500 |
| Threshold: higher-rate taxpayer | £75,000 | £19,000 |
A £38,000 savings pot isn’t chump change, certainly. But it’s not really that big when you consider the standard advice is to save six months of your salary as an accessible emergency fund.
Come back cash ISAs, all is forgiven
I must admit, I’ve given cash ISAs the cold shoulder in recent years. It seemed more sensible to use my ISA allowance to passively invest in a shares ISA instead.
This year though, I’ve allocated the majority of my annual allowance to my cash ISA. This is solely because I’d probably breach my savings allowance on the interest I’d earn if I’d added more money to my standard savings account.
I say ‘probably’ because of the likelihood the variable rate on my easy-access savings account will increase over the next few months. There’s also a (smaller) chance I’ll be promoted at work, which would enable me to put away more cash. Assuming I avoid the temptations of lifestyle inflation!
The appeal of cash ISAs is that while interest rates are typically lower than those offered on normal savings accounts, anything you put in any ISA will be exempt from tax forever after.
This means your personal savings allowance isn’t affected by whatever you earn in your cash ISA.
However you’re limited as to how much you can put into an ISA each tax year. This allowance is currently £20,000 a year.
The best savings rates available
There’s a host of generous savings deals out there.
Easy-access savings
If you don’t want to lock your cash away – or you think interest rates on fixed accounts will soon be even higher – then an easy-access account might be best for you.
Right now you can earn 2.6% variable with Paragon Bank – though you can only make three withdrawals per year or the rate drops to 0.75%. If that’s not for you then app-only Atom Bank pays a slightly lower 2.55%.
Paragon requires a minimum deposit of £1. For Atom there is no minimum.
Fixed-rate savings
If you’re happy to lock away your money, then you can boost the interest rate on your cash.
Investec currently pays the highest one-year fixed rate of 4.36%. You can open it with £5,000.
Higher rates are available with longer fixes, though locking away your cash for even more time may not be attractive given the backdrop of rising rates.
Cash ISAs
Are you close to exceeding your personal savings allowance? You may wish to open a tax-efficient cash ISA.
But do remember you can only stash up to £20,000 across all types of ISA in a given tax year.
The top easy-access cash ISA right now pays 2.75% variable, via Earl Shilton Building Society. You can open an account with just £10.
Alternatively, Principality BS pays a slightly lower 2.5% variable.
As for fixed-rate cash ISAs, Kent Reliance pays 4.4%, fixed for two years.
Note that you can withdraw cash early from a fixed-rate cash ISA – but you’ll be charged an interest penalty if you do so.
For Kent the early withdrawal penalty is 180 days interest, for instance.
All these accounts are covered by the Financial Services Compensation Scheme.
Are you thinking about the personal savings allowance? Have you opened a cash ISA this year? Share your thoughts and strategies in the comments below.
- All interest rates on savings products in this article are AER, aka annual equivalent rate. [↩]
Good article. Agree this is soon to be more of an issue than it has been recently with interest rates on the rise.
I’m loathed to use valuable ISA allowance to hold cash, bonds are a struggle enough!
Perhaps it might be worth mentioning various methods of “saving” which don’t fall under into savings allowance sights offset mortgages and premium bonds being the two that immediately spring to mind. I’m seriously considering the former when my fixed rate deal expires mid 2023.
I think is another thing that should be chopped to be honest, why should people with some savings get an extra tax free allowance on top of an already hyper generous 12,500 personal allowance
Re: “Higher rates are available with longer fixes, though locking away your cash for even more time may not be attractive given the backdrop of rising rates.”
Or, if you believe the BoE inflation forecast, it might actually be a good idea, as in a year or two, the five-year fixed savings rates available today, could be double inflation. And apparently, five-year fixed mortgage rates are now coming down too. What do you think?
@Neverland – I expect it exists to make the tax system simpler. When interest was deducted at source, many people had to claim it back. Now it’s paid gross and, with the personal savings allowance, most people don’t have to complete a tax return. All that will be about to change.
It looks as if Kent Reliance has pulled its 4.4% two-year fixed cash ISA. Yorkshire BS still has a 4.4% three-year fix. Or at least they did this morning. At the moment the best rates are pulling back a bit, presumably because everyone is expecting somewhat lower rises in the bank rate ahead.
@Matt – It doesn’t seem to simplify the tax system for those of us who exceed the PSA. HMRC now issue me with four or five PAYE tax code notices every year because at they are having to predict the interest I will “earn” this year on the basis of what I earned in the last tax year but one. They won’t collect the data on what I earned in the last tax year until some time during the current tax year, which means what I paid last year was wrong and they’re trying to recover from that on the basis that last year I probably collected the same interest as I did the year before. Eventually they’ll discover that was wrong, and they’ll try and correct that.
@Neverland – I think I’m more irritated by the fact that I (and people who earn a lot less than I do) are paying 32% (Income Tax and National Insurance) on the money we have to work for, but only 20% on the savings income that I (and people who earn rather more than me) sit back and collect.
I still think the PSA is irrelevant. Unless you’ve used up your ISA allowance (and your partners ISA allowance) then there’s no good reason to be saving outside of an ISA. Even a cash ISA. It just makes no sense.
For years Martin Lewis has been telling people maybe they’d be better off taking a marginally higher interest rate outside of an ISA, because the PSA meant they could save a buttload without paying tax anyway.
That short term thinking has come back to bite people who followed this advice and those who accumulated large sums are unsheltered.
Premium bonds pay 2% (with average luck), which is £1000/yr on the maximum holding and a perfectly reasonable default savings account for a higher rate saver until easy access rates reach 3.5%
@David C — Kent has pulled it already? Maybe it was this article… it’s been a nightmare trying to keep in-force deals alive on this page through the process of The Treasurer submitting to me sub-editing to publishing. We’ve changed nearly all the products at least once, and did some again yesterday!
I guess the lesson is you need to move quick.
Regarding whether it’s best to fix for five years or keep your options open, it’s certainly tricky. Probably best to split the difference across two accounts.
I’ve entered this nightmare uncertainty zone with my remortgaging window finally coming up (regular readers will remember that for *a long story* I was not able to remortgage until this window opened, despite writing articles warning about the impact of higher rates all year… 🙁 )
I may fix for two years, but both the SVR and a five-year fix are on the table for competing reasons. But the stakes are much higher than the interest rate on cash savings, at least for most people who aren’t living on their interest.
My emergency fund is currently in premium bonds. But I suspect I’d stay flexible with cash if I had more to spare, as we’re definitely in changeable weather at the moment.
@TI:
Re: “My emergency fund is currently in premium bonds. But I suspect I’d stay flexible with cash if I had more to spare, as we’re definitely in changeable weather at the moment.”
Why not hedge your bets and fix half for as long as possible and keep half fully flexible?
BTW, a similar strategy, sometimes called part-and-part, can be applied to mortgages (albeit the products must be from the same lender). And, IIRC you can even mix repayment and interest only too.
@TI – It was the “…and unsurprisingly fixed-rate savings rates might have peaked, too ” link to This Is Money in last weekend’s Weekend Reading that triggered me into opening the Kent Reliance fixed ISA while I still could, so you’ll get no complaints from me! Maybe things will change after the next MPC meeting, but as William Golding says “Nobody _knows_ anything”. I hate to say it, but MoneySuperMarket’s Cash ISA tool is pretty good, so long as you go into “Choose Provider” and switch off “Only show results I can open through MoneySuperMarket”. But even they don’t include Kent Reliance.
There’s more technicality to the PSA than described above.
The £1000 is actually the lowest limit of an allowance that starts at £5000 and is then reduced by the value of your income including interest over and above the personal income tax allowance, (£12570).
For example, if you earned £12570 and received £2000 interest, your PSA would be £5000 – £2000 = £3000 and you’d pay no tax on your £2000 interest.
If you earned £14000 and received £2000 interest, your PSA would be
£5000 – (£14000 + £2000 – £12570) = £1570 and you’d pay tax on the £430 balance of your interest.
And so on down to the minimum PSA of £1000.
@al cam you certainly can
.my mortgage is mostly interest only with a small (12%) amount repayment at present
@Al Cam — Again, I can’t do anything fancy or interesting with my mortgage. I can re-mortgage with my bank (which is very competitive for existing customers, thankfully).
If I could have done anything nifty I guarantee I would have re-mortgaged below 2% or even around the 1% mark. I don’t think that’s hindsight bias but even if it is then I would have been remortgaging when I was writing about stress testing your mortgage to rising interest rates earlier this year! 🙁
Reminder of why: https://monevator.com/i-asked-the-chief-executive-of-a-bank-to-give-me-a-mortgage-and-he-did/
My income is almost a rounding error versus my mortgage (but even more so against my portfolio). Nearly all banks don’t want to know. The very few who did wanted to assume control of the investments. Alternatively I could borrow at say Interactive Brokers but absolutely no way am I marking-to-market against debt like that! 🙂
Anyway this is all OT. I’ll do a post on my mortgage for general food for thought purposes when the time comes no doubt.
@Investor
You haven’t re-mortgaged yet?
Oh boy, I can’t wait for that article, I’ll get my popcorn in the cupboard now
Remortgaging is central to my UK nuclear winter scenario
I was hoping this article will answer the question I had for a while now. If I have £500 allowance for earning interest on savings then do I pay any tax if my savings are in 3 year fixed bond savings account and it generates interest worth £500 every year? The interest is added annually but paid out at the end of term, at account maturity? Which means I would get £1500 worth of interest, so would I pay tax on the outstanding £1000?
I was also wondering if I could give my partner cash so she would put it in her isa. At maturity cash along with interest earned would be spend to pay off the mortgage.
@David C
“I think I’m more irritated by the fact that I (and people who earn a lot less than I do) are paying 32% (Income Tax and National Insurance) on the money we have to work for, but only 20% on the savings income that I (and people who earn rather more than me) sit back and collect.”
I’m totally with you.
The reason why the taxes on the employed are so high is that:
1) tax base is narrow with huge minimums e.g. £85k for VAT and £1m for IHT
2) Low taxes on certain types of gains for no reason e.g. CGT and divs
3) Huge deductions like SIPPs, BATR, VCT, EIS, private equity carry, non-dom, offshore trusts, gifts, farmland etc.
Its a choice. You can’t have lower taxes for employed graduates unless you do a major job on 2 or 3 of those – or dramatically cut the NHS or pensioner benefits
The Office Of Tax Simplification did good work on that, then – surprise! – it got abolished
@TI:
I hear you!
Out of curiosity are you saying your bank will only do you:
a) a two-year fix, or
b) SVR, or
c) a five-year fix,
and not some combo of the above?
@Barry
I thought you could have the £5k starting rate and £1k PSA if you were a standard rate tax payer – so £12570 in wages and £6000 interest, all tax free – is it 6k sliding down to £1k or £5k sliding down to £1k, for 20% payers?
@Al Cam
To my knowledge Atom Bank was the only neobank doing mortgages in 2019 and I think they still are, the rates are like, ouch
https://www.atombank.co.uk/mortgages/remortgage/
Cheapest two year fix is c. 5.5%
Average two year fix in 2019 for a 75% LTV in 2019 was 1.4-1.6%, source: https://www.ft.com/content/c41094b4-050d-4522-88ad-fc9a9829bd80
Saw this one coming after many years of very little interest on High Interest BS Accounts
I keep 2-3 years in cash for living expenses and coping with sudden market downturns
Set up 2 instant cash ISAs ( new vehicle for me)which now have got half the cash pot safe from tax and the high interest BS account has enough but not too much to break the £1000 allowance
May need a reduction in high interest BS account amounts of cash in April as will then be possibly into a full financial year of current higher interest rates
ISAs will be free again so excess monies will go into these tax free havens again
2.5% interest rate generates £1000 of savings interest on £40000 as a rough indicator for action
xxd09
Much as I’d like to give @NL more ammunition to snipe at me from his tower of absolute prescience and perfect decisions in all things (1) I didn’t buy in 2019, as that article notes (2) the rate I’m being offered from my bank is significantly lower than that. (At that rate I think I’d probably just repay at least half the balance).
@Al Cam — I probably could get a mixed mortgage looking at the switching options again, but it doesn’t do much for me given that it would only increase my monthly payments.
My situation is my situation though. Many different ones out there. 🙂
@TI:
You know your situation.
All I can say is that in the past I used a mix of fixed rate and fully flexible SVR quite successfully. At that time my fear was rising rates (although the strategy works equally well against falling rates too). Although I paid initially more for the fix than the SVR, I gained (paid less overall) as rates did increase. I think I set them both up as repayments, but I am not 100% sure. The SVR definitely was a repayment as I gave myself a stretch to try and clear the SVR balance by the time the fixed rate expired.
This was a good few years ago and rates were somewhat higher than they are now. Also, I suspect a lot of the ‘benefits’ I gained were really behavioural – as I did manage to clear the flexible SVR mortgage around when the fixed part came up for renewal, but that is another story really.
@Barry and @Boltt
The PSA in this article is entirely separate from the £5k starting rate of savings income taxed at 0%; note it’s still part of the tax calculation.
The starting rate has to be within your first £5k above the Personal Allowance £12,570, if any actual income is in that first £5k you lose it.
Assuming that you have no other income getting in the way of the £5k band, the PSA could end up falling in the £5k. If you don’t have enough savings income to use up the whole £5k.
If you do then you can benefit from both the PSA and starting rate to total £6k of tax free savings income.
Hope that makes sense!
Thanks Planalyst – it’s an odd allowance and difficult to explain succinctly. Not really sure why it exists with ISAs being available. I bet the Recent changes in HMRC BTL interest removes this for some people, due to the way interest is credited back at the end of the tax calculation!
I am due my pension lump sum in the next couple of weeks. As part of my plan I was intending putting 20k in a cash ISA. As there is an indication that interest rates may rise at the next BOE announcement would it be worth hanging on or jump in now before they disappear?
@Peter
Good question. I’ve recently opened a 1 year fixed bond, and opted for the interest to be paid monthly so that it was split across two tax years – but now you’ve got me worried. Mind you, what would be the point of them giving me the option of annual or monthly interest, given that I can’t withdraw until the end of term, unless it was because of tax implications? Can anyone confirm?
There are some slightly better Cash ISA rates out there at present, though not available to all. If you happen to hold a Nationwide Help to Buy ISA (no help if you own property of course), they’re paying 3% from next month.
More widely available is Virgin Money’s Cash ISA paying 3% now, but it requires you to hold their current account to open it.
@ xddo9 “I keep 2-3 years in cash for living expenses and coping with sudden market downturns” – curious to know what is your plan if downturn takes more than 3 years. I have my personal 15 years, Japan like scenario to cover here.
I suppose Peter that I would then resort to my bond portfolio for drawdown which currently is 62% of my portfolio
Bonds of course are supposed to be a “safer” haven for your monies-not this year!
It has never come to that yet but who knows
Equities in fact have provided 99% of drawdown monies over the years
Usually top up my cash fund once a year in May/June
Smelling blood in the water(old experienced investor?) I topped up cash fund early last year before the downturn and even took a bit extra
Aged 76 now so time is on my side ie portfolio,s job is nearly done
So far however portfolio has always recovered in time with equities leading the way as you would expect
Currently it would seem market has bottomed out and is slowly starting to rise again but who knows?
I have a couple of years of drawdown cash left at the moment so will probably “escape “ once more
xxd09
PS currently portfolio would cover 29 years of withdrawals before depletion-surely we will get some growth before then!
@Andrew I agree except if you suddenly have a large windfall (e.g. asset sale, inheritance, bonus) and have excess after the ISA allowance is full, especially as a positive spike often comes along with a large tax bill to pay in a few months time.
@xxd09:
Re: “PS currently portfolio would cover 29 years of withdrawals before depletion-surely we will get some growth before then!”
OOI, roughly how many years ago did you retire, and do you recall how many years of forecast withdrawals your portfolio would provide for then?
Retired myself in 2003 and teacher wife in 2005
I cannot answer your second question as hadn’t appreciated that metric at that time-learnt a lot in the last 20 years!
I used a 4% withdrawal rate (Trinity Study) as a guide and took withdrawals that way -tended in practice however to be nearer a 3% withdrawal rate than 4%
(The blog by Behavioural Investment entitled “What Next for Defensive and Cautious Investors After a Torrid 2022” in today’s Monevator items/blogs was interesting as information on what I did and am doing ie 30/70 -equities/bonds -cautious portfolio )
Timing/Luck plays a big part in investing/retirement-unfortunately not under the Investors control
It turned out the a lucky time for me to retire
The Investor can however save a lot, keep costs as minimal as poss ,use index trackers and live frugally
Worked so far for me
xxd09
@xxd09:
Thanks very much for the additional info.
I would summarize your post retirement financial journey as follows:
retired in 2003 (some 19 years ago) with a Pot of at least 30 years of forecast withdrawals; and todays Pot would sustain about another 29 years of withdrawals – noting that income drawn from the Pot was, from the appropriate dates, supplemented by two state pensions and one teacher’s pension.
Indeed it “turned out [the] a lucky time for me to retire”. Especially given how unlucky pulling the plug just three years earlier (in [August] 2000) seems to have been!
Thanks again – real data / stories are just so much more illustrative than dry numbers and graphs.
@ Neverland (2)
Because those people with some savings, have put up with P— P— interest rates for 12 years, many being pensioners. And if they retired many years ago and have the temerity to survive, their state pension is what is was 15/20 years ago plus the paltry increases over the years.
Another sacred cow that you may want to have a pop at is the 40% pension contribution tax relief for higher earners, which I understand costs £50 Bn per year. More than enough to fill Jeremy Hunt’s “Black Hole” I don’t want it stopped, just give the shelf stackers, paramedics et al the same opportunity to contribute at the same rate, or is that being too fair.