Savings income and the rise in higher rate taxpayers

Bank of England base rate increases, coupled with higher savings rates and frozen tax thresholds, are seeing more people pushed into the higher rate taxpayer category, or paying more tax on savings income. Tax-efficient investments could mitigate this burden.

National Savings & Investments (NS&I) is currently offering a one-year savings bond with a table-topping fixed rate of 6.2% – the highest on offer since this product’s launch. A higher rate taxpayer will use up their £500 savings allowance with just over £8,000 invested in this bond. With £25,000 invested, there will be more than £1,000 of taxable savings income. However, it wasn’t that long ago that a higher rate taxpayer could have had £100,000 invested before facing tax.

No surprise, then, that the number of taxpayers paying tax on savings income for 2023/24 is expected to be a million more than last year.

It is estimated that over 2.7 million taxpayers will have to pay tax on their savings income in this tax year, including nearly 1.4 million basic rate taxpayers – even though they have a higher (£1,000) savings allowance.

The sudden increase in savings income is likely to catch many savers out. There are two ways that HMRC will collect these extra taxes:

  • Adjusting an employee’s tax code, with the tax deducted along with normal PAYE. Such an adjustment will not happen until HMRC receives a customer’s details from the relevant financial institution, and this will be after the tax year has ended.
  • Including details of savings income on a self-assessment tax return and paying the tax along with normal self-assessment payments.

In both cases, taxpayers should keep careful track of the savings income they receive, especially if accounts are regularly opened and closed. Tax codes are notoriously inaccurate, so adjustments for savings income should always be checked.

Minimising tax where you can

Once taxpayers realise the tax implications of higher interest rates, they will want to minimise any future liabilities. Here are a few suggestions:

  • Make the best use of Individual Savings Accounts (ISA) accounts.
  • Consider moving funds into tax-free premium bonds. Although interest is not paid as such, if you have larger investments (£10,000 plus) you can expect regular winnings. A tax-free return of 4%, for example, is equivalent to a gross 6.67% for a higher rate taxpayer.
  • Should your partner not be making use of their savings allowance, look at moving savings into joint names.
  • If your marginal tax rate is expected to fall in a year or two’s time, put funds into longer-term accounts where interest will end up being taxed at the future (lower) tax rate. For example, NS&I has a three-year fixed rate bond paying 5.7%. Interest is not taxable until the year of maturity.

Higher rate tax

Just as savers are being caught out with increased interest rates, more taxpayers are being inadvertently brought into the higher rate tax net because of frozen tax thresholds, and the personal allowance and the basic rate tax threshold having been unchanged since 2021/22. HMRC statistics show the number of higher rate taxpayers for 2023/24 growing over 40% since 2020/21.

There are no extra administrative requirements when moving into a higher rate tax band, but taxpayers will want to minimise their liability. One problem will be that many simply do not have any spare funds to lock away in tax planning measures.

For those who are not so constrained:

  • Pension saving becomes more attractive where each £100 invested effectively only costs £60.
  • Life assurance-based bonds could be useful – these permit an annual 5% tax-deferred amount to be withdrawn with no tax consequences until maturity.
  • Employees might also want to consider a salary sacrifice arrangement involving a tax-efficient car or pension contributions to ease some of the income tax burden.