The Bank of England's decision to raise interest rates for the first time in over three years has prompted a warning to savers holding more than £11,000 in bank or building society accounts, as higher returns could push them over tax-free personal savings allowances.
BBC Radio 4's Moneybox programme heard from financial expert Rachel Springall, who cautioned that while rising rates may seem welcome for savers, they could also create a tax liability. The central bank raised borrowing costs to tackle the rising cost-of-living burden on households and businesses, and warned that inflation is on course to climb to approximately 5%.
Bank of England Governor Andrew Bailey also indicated that further increases are likely should the Iran war remain unresolved.
Tax changes for savers
In last month's Budget, Chancellor John Healey raised tax rates on savings interest. Rachel Springall, from financial data firm Money Factors, commented on the Bank of England committee's unanimous decision to raise rates, telling Radio 4 listeners: "It's a huge impact and gives us more of an indication of where rates might go."
She added: "I've had a look through a lot of the columnists' opinions on this one and they are expecting another rate rise unfortunately probably by the spring and there are some murmurings about another one later in the summer."
"So it's not over yet. But as the Bank of England estimated, because of the uncertainty over the war, that's the path, and the worry about prolonging inflation, and if we prolong inflation, we could get more interest rate hikes."
Impact on savings allowances
Presenter Paul Lewis noted that the committee had indicated it anticipates inflation climbing to 5%, which carries significant implications for savers. Ms Springall said: "Next year there's a lot going on for savers. We're getting an increase in savings tax by around 4% across the board. So having higher interest rates can feel like a good thing because you're getting more return."
"But higher inflation means your money doesn't go as far and potentially breaching your thresholds for your personal savings allowance. And when you do that you get taxed so this is why cash ISAs and stocks and shares ISAs because you can protect your money from that."
Basic rate taxpayers (20%) are permitted to earn up to £1,000 in savings interest tax-free each year, higher rate taxpayers (40%) can receive up to £500 in savings interest tax-free annually, while additional rate taxpayers are liable for tax on all savings interest. This means a basic rate income taxpayer can hold £22,222.22 in savings at a 4.5% interest rate before they become liable for tax on their savings interest. A higher-rate taxpayer, by contrast, needs only £11,111.11 in savings at a 4.5% interest rate before tax on savings interest becomes due.
From April 2027, the levy on savings income will rise to 24% for basic rate taxpayers, up from the previously scheduled increase of 22%.
Advice for savers
Chartered financial planner Ray Black, founder of Money Minder, said: "There is a starting block of a bright side. Not everybody with savings is going to pay more tax. We've still got the personal savings allowance that's £1,000 for basic rate taxpayers, £500 for higher rate taxpayers, and the ISAs still remain tax free."
"So the people who have got savings of somewhere between £20-25,000 and they're getting top rates of somewhere between 3.5 to 4 per cent - they may not feel the pinch of this extra tax at all. However there is those people that have got more than £1,000 savings interest coming in and it's a 20 per cent increase for them."
Mr Lewis added: "The number of higher rate taxpayers has doubled to 8 million since the threshold freeze started in 2022. They'll be paying 44%. Is there a way of planning for it?" Mr Black said: "First and foremost, you really need to understand how much interest you're making in the bank. So £20-£25,000 if the interest you're getting is under £1,000 per person."
He urged people to make use of tax-free ISAs. A caller named Janet told the programme: "I get my money mainly from savings. My ex-husband gets his income from pensions. As a result of this budget for the same income I will be taxed at a 4% higher rate than he is." Mr Black described the outcome as not 'fair'. A further caller raised the issue of her mother having substantial funds set aside for care home costs, which would now face heavier taxation.
Listener Christopher characterised it as 'taxing prudence.' Responding to the budget, personal finance expert Mr Lewis said: "Problem on savings though. If you're saving and you pay tax on the interest, so you've used up your ISAs, you've used up your personal savings allowance, the £1,000 pounds of interest you can make a year tax free from savings."
"Well, from April 2027, the interest on savings, the tax rates going up. Basic rate taxpayers will pay 24%, high rate taxpayers 44%, top rate taxpayers 49%. Basically, the normal rate plus 4%. So, it's worth making sure you use your tax free allowances."
