Look out for the cash savings interest tax trap

More people will have to pay tax on their savings interest this year due to increased interest rates coupled with a frozen tax free savings limit. If you are in this position and do not complete annual tax returns, you need to notify HMRC of your liability to tax or you could face penalties.

A basic-rate taxpayer – with income up to £50,270 – can receive a total of £1,000 of savings interest before having to pay tax; for higher-rate taxpayers that limit is just £500.

Additional-rate taxpayers – those with income over £125,140 – have to pay tax on all their interest.

You may have the choice of rolling up all the interest until the end of the term. If you receive all the interest on maturity it will all be taxed in the one tax year.

If you complete a self-assessment tax return each year, you will already be declaring your savings income. Most employees do not complete tax returns so should check whether they have received more interest than their tax-free limit. Banks inform HMRC of all interest paid to savers, but it remains the responsibility of each person to declare any taxable income.

There are ways to minimise your tax. Interest earned in a cash ISA (individual savings account) is free of tax and anyone aged 18 or over can put up to £20,000 a year into an ISA. Couples may be able to save tax by putting savings into the name of the lower earner rather than a joint savings account in which interest is taxed 50-50 between them.

If, to maximise your interest rate, you save into a longer-term, fixed-rate account, you may have the choice of rolling up all the interest until the end of the term or receiving it annually or monthly. If you receive all the interest on maturity, it will all be taxed in the one tax year, meaning more of it is likely to exceed your tax-free limit.