What is the personal savings allowance?

The personal savings allowance (PSA) is an important tax allowance that lets many people earn up to £1,000 in interest on cash and certain investments each year without paying tax on it. Tax-free interest started in April 2016 when the government introduced PSA to encourage people to save more of their money.

The allowance you get depends on what rate of income tax you pay:

• Basic rate (20%) taxpayers can earn £1,000 of interest in the 2024/25 tax year before paying tax
• Higher rate (40%) taxpayers have a lower allowance of £500
• Additional rate (45%) taxpayers don’t receive any PSA

If you are a Scottish taxpayer, you’ll pay different rates of income tax, but for the purposes of the personal savings allowance the English bands are used, which means for 2024/25, the full £1,000 PSA will generally apply if overall income does not exceed £50,270.

To benefit from this tax-free savings allowance, you don't need to do anything. Banks and building societies automatically pay interest without tax deducted. However, if you exceed the threshold, you may need to declare your savings interest on a self-assessment tax return.

What counts as interest for the personal savings allowance?

This is very important and could catch out the unwary. It’s not just returns on cash, either from interest or expected profit from sharia bank accounts, that counts as interest.

Income from certain investments do too, including unit trusts and open-ended investment companies where income is classed as interest rather than dividends, government bonds (gilts), corporate bonds, purchased life annuities and some life insurance contracts.

However, savings and interest-bearing investments in tax-free accounts like Individual Savings Accounts (ISAs) as well as returns from a small number of National Savings and Investments accounts, notably Premium Bonds, do not count towards the allowance.

Is this different to the income tax personal allowance?

Yes, the income tax personal allowance (currently £12,570) is the amount of income of any type someone can earn in a tax year without paying tax. The PSA is on top of this general allowance and is separate to the dividend allowance which is £1,000 in the 2024/25 tax year.

What is the starting rate for savings?

There is also a ‘starting rate’ for savings, which is a special 0% rate of income tax for savings income of up to £5,000 for those with taxable income below £17,570 in 2024/25.

You’ll only get the full starting rate band if your other income doesn’t exceed the personal allowance of £12,570. But it does mean if interest is your only form of income you can receive up to £18,570 in savings interest tax-free through the combination of the income tax personal allowance, PSA and starting rate for savings.

Did the PSA change in the Budget?

There were no changes to income tax outlined in the chancellor’s 2024 Budget, which means income tax bands and allowances continue to be frozen and the PSA remains the same. Instead, the focus was a further reduction of national insurance, which reduces the tax burden on earned income only.

In the past, tax bands and allowances have tended to rise each year with inflation and the ongoing freezing of these is becoming a greater issue for many taxpayers. This is particularly the case for savers who, having experienced a loss of spending power as interest rates trailed inflation, now face a greater tax burden on rates that more closely match rises in the cost of living.

This will have become a greater issue for the 2022/23 tax year that individuals with presently be reporting on via tax returns, and even more so for the 2023/24 and 2024/25 tax years as interest rates have increased. Some cash savers are getting four or five times the interest they received a couple of years ago on the same sum.

Many savers with relatively modest amounts in bank and building society accounts are therefore likely to pay tax on savings as higher interest rates increase income.

• By way of an example, you only need to have £20,000 in savings attracting an average rate of 5% to use up the personal savings allowance of £1,000 if you are a basic rate taxpayer.
• For a higher rate taxpayer just £10,000 of savings would use up the lower allowance of £500 at an interest rate of 5%.

With lots of competitive cash options available, including through Charles Stanley Direct Cash Savings, it’s really important to be aware of your tax liability so you are not caught out unexpectedly. Follow the link to see the full 2024/25 tax brackets.

How does the PSA apply to fixed rate cash accounts?

If you opt for a fixed-rate savings account, you pay tax on your interest in the year you can access the money. This means all the interest built up, even if it is over multiple tax years, falls into your income and PSA at that point. This contrasts with other account types such as easy access or notice accounts where interest accrues regularly, and is taxable accordingly, as you go.

How can I keep within the PSA?

If it’s looking like you might exceed your PSA, you could consider using an Individual Savings Account or ISA where interest is tax free. You can add up to £20,000 to ISAs each tax year across the various types including Cash and Stocks & Shares.

If you are married or in a civil partnership you could consider joint accounts or splitting the money in order to take advantage of two PSAs, or a higher PSA available for one party.

Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.