To understand savings interest, you should first understand how a savings account works with interest rates. Certain savings accounts will encourage you to save by rewarding you with an annual percentage of interest added to your total. The actual rate you get can vary depending on the type of account you have, how long you’ve kept the money in there undisturbed and the financial institution offering it.
Types of account can be:
- Cash ISAs – tax-free interest accounts
- Easy access savings – allows you to withdraw and return as you please
- Notice accounts – you have to notify your provider when you’d like to withdraw
- Regular savers – you have to save regularly (e.g. monthly) with a fixed sum
- Fixed-rate bonds – this offers you a fixed interest rate over a certain period of time
- Help to Save accounts – these are tax-free accounts with a bonus at the end
Are you taxed on savings interest?
In short, yes. On non-tax-free accounts, if you receive interest above the Personal Savings Allowance (£1,000 if you’re a basic rate taxpayer or £500 if you’re a higher rate taxpayer), you need to declare it. You’ll then be liable to pay Income Tax on it.
The tax in action
- Joni earns £80,000 from salary and has no other earnings
- She opens a savings account which pays 2% interest per year
- She puts in her savings of £30,000 for a whole year and does not touch the account
- At the end, she’ll have earned £600 in interest
- Her salary is over the higher tax rate threshold (£50,000 in 2020/21), so she’ll have to pay higher rate Income Tax on £100 worth of interest: 40% * £100 = £40
- Her income from savings interest and investment is under £10,000, so she can either call HMRC and have them change her tax code, or file a Self Assessment tax return to pay the £40 tax bill
Read more about how it works with HMRC online.