Tax rates on savings interest will rise twice as much as previously planned, the Chancellor John Healey announced in his Budget. Savers will face an additional 2 percentage point increase on top of the 2 percentage point rise already scheduled, in a move predicted to cost taxpayers £125 million next year and £500 million by 2028-29. From April 6, basic rate taxpayers will pay 24 per cent tax on savings interest, higher rate taxpayers 44 per cent and additional rate taxpayers 49 per cent. This means higher and additional rate taxpayers will hand almost half of all the interest they earn to the taxman.
The tax burden on savings has already grown significantly. UK taxpayers now pay £2.8 billion in tax on bank interest, four times as much as they did four years ago. Laura Suter, head of personal finance at investment group AJ Bell, described the rise in rates as 'hefty' and predicted it will make the situation worse. Pensioners are expected to be among the worst hit, as they often hold substantial amounts in cash to spend during retirement.
For those with smaller savings pots, there are ways to avoid the tax entirely. Anyone with £10,000 in savings can use the personal savings allowance, which allows basic rate taxpayers to earn £1,000 in savings income tax-free, £500 for higher rate taxpayers, and nothing for additional rate payers. However, using Individual Savings Accounts (Isas) offers broader protection. Savers can put £20,000 into cash or stocks and shares Isas each year, where money grows free of tax. For those with £20,000 saved, putting the full amount into an Isa shelters all interest from tax.
For larger sums, the strategy becomes more complex. Someone with £50,000 who puts £20,000 into an Isa still faces tax on the remaining £30,000. According to calculations based on 5 per cent interest, this would generate a tax bill of £360 for a basic rate taxpayer, £880 for a higher rate taxpayer and £1,225 for an additional rate taxpayer. To reduce this, savers can use Premium Bonds, which offer tax-free prizes with a prize rate of 4.35 per cent. Jason Hollands, of wealth manager Evelyn Partners, said Premium Bonds now make sense for some people after the tax changes.
For very large savings of £100,000 or more, short-dated government bonds known as gilts offer another option. While the regular interest payments on gilts are taxable, gains on qualifying gilts are exempt from capital gains tax. This means buying a gilt below its £100 face value can provide a tax-free gain if held until maturity. Isabella Galliers-Pratt, senior investment director at Rathbones, calculated that for some savers, this approach can be equivalent to earning 8.4 per cent in a regular savings account.
For married couples with substantial savings, splitting accounts between partners allows them to use both sets of allowances. By putting money into accounts in their partner's name, savers can shield an additional £20,000 in Isas and another £50,000 in Premium Bonds. For basic rate taxpayers with £100,000 in savings earning 5 per cent in a regular account, tax would total £960 annually, but using a combination of Isas, Premium Bonds and gilts could reduce this to nothing.