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Why the personal savings allowance is suddenly important again

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:

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 [1]. 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 [2] 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:

Fast-forward 12 months:

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 [4].

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 [5] 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 [6] more cash. Assuming I avoid the temptations of lifestyle inflation [7]!

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 [8] 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 [9] – 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 [10] 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 [11] 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 [12]. You can open an account with just £10.

Alternatively, Principality BS [13] pays a slightly lower 2.5% variable.

As for fixed-rate cash ISAs, Kent Reliance [14] 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 [15].

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.

  1. All interest rates on savings products in this article are AER, aka annual equivalent rate. [ [18]]