With interest rates still near historic highs and a long way to go before they return to pre-pandemic levels, it may be time for some people to review the status of their savings and determine whether or not taxes are payable on the interest.

Although the Bank of England has started cutting interest rates, the base rate is currently 5% – an amount that should also be passed on to retail savings accounts.

At the same time, inflation has pushed up wages, which could cause people to slip into higher tax brackets than before.

The UK household savings rate – the percentage of a household’s disposable income that is saved – has risen in recent quarters as cost-of-living pressures increase and cheaper interest rates are offered on bonds and savings accounts.

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Here are some things to consider when managing taxes and savings, according to experts, to help you get the most out of your emergency fund.

Tax-free allowances

An important point to consider when managing your savings is the limit of your personal savings allowance (PSA). This allows you to receive interest on your savings without having to pay tax on it and depends on the amount of income tax you pay.

“The saver allowance is still at the same level as when it was introduced in 2016, so savers are likely to still have to pay tax on the interest they earn, especially considering that income tax thresholds have been put on hold until 2027-28,” said Alice Haine, financial analyst at Evelyn Partners.

“Frozen personal tax allowances mean that millions more taxpayers will have to pay higher taxes because inflation pushes up their wages.”

Basic rate taxpayers, who pay a rate of 20%, can earn up to £1,000 before they have to pay tax. Higher rate taxpayers (40%) are limited to £500 before they have to pay tax on savings. Additional rate taxpayers – those paying 45% – do not get an allowance unless they opt for certain savings products.

Those earning less than £12,570 a year can earn up to £18,570 in tax-free savings interest, although this depends on many variables, such as how much income comes from pension and how much from work.

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Once you receive more interest on your savings than the allowance, you will have to pay tax on the interest according to your income tax rate. For example, a basic rate taxpayer who receives £2,000 of interest on their savings in a year from non-ISA accounts will receive £1,000 tax-free and will have to pay 20% tax on the rest, which equates to £200 in tax.

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“Savers who are close to the next income tax bracket also need to be careful that their savings interest does not catapult them into the next tax bracket,” warns Laura Suter, director of personal finance at AJ Bell. “That would mean losing part of their tax-free saver allowance, but also having to pay a higher tax rate on the savings interest.”

“For example, if someone falls into the higher tax bracket, their personal savings allowance will be reduced from £1,000 to £500 and they will have to pay 40 percent tax on the savings interest falling into this bracket, instead of 20 percent.”

“Similarly, someone who falls into the additional tax rate tax bracket would not receive a personal savings allowance and would have to pay 45% on their savings income in this bracket.”

Does my tax allowance apply to all my savings accounts?

The PSA covers all savings in non-internet savings accounts (ISAs) and is per person, not per account.

Until now, all savings were tax-free for most people thanks to the PSA.

Since interest rates have risen considerably in recent years, this is no longer the case.

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According to the government website, it covers any interest you earn from savings in banks and building societies, investments in investment companies and funds, peer-to-peer lending, certain bonds and credit union accounts.

All money held in ISAs is tax-free and any interest earned on them does not count towards your PSA.

“Other ways to protect your savings from tax include topping up your private pension or investing up to £50,000 in NS&I Premium Bonds,” said Haine.

Are ISAs and LISAs for stocks and shares included?

All money held in ISAs is tax-free and any interest earned on them does not count towards your PSA.

The annual allowance for Individual Savings Accounts (ISAs) is £20,000 for the 2024-2025 tax year. This limit applies to all ISAs you have, regardless of how many there are. You can use the allowance to pay into Cash ISAs, Stocks and Shares ISAs or other types of ISAs.

Do I have to fill out a tax return?

Unless you have any other income as a self-employed person, you do not have to fill out a tax return – hurray!

Banks notify HMRC of the interest received each year and your records are updated on this basis.

Any charges will be communicated by means of a calculation and tax class change.

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