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 tabletopping fixed rate of 6.2% – the highest on offer since this product’s launch in 2009. 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. Over 2.7 million taxpayers are estimated to 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.

Dealing with change

The sudden increase in savings income is likely to catch many savers out. HMRC will collect tax either by:

• Adjusting an employee’s PAYE tax code after receiving the customer's details from the relevant financial Institution – after the tax year has ended.
• Self-assessment payments after a taxpayer submits their tax return.

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 ISA accounts.
• Consider moving funds into tax-free premium bonds. Although interest is not paid as such, those with larger investments (£10,000 plus) can expect regular winnings.
• Move savings into joint names if a partner is not maximising their savings allowance.
• Putting funds into longer-term accounts where interest will end up being taxed at the future (lower) tax rate, if your marginal tax rate is due to fall in a year or two’s time.

Over 2.7 million taxpayers are estimated to have to pay tax on their savings income this year, including nearly 1.4 million basic rate taxpayers.

Higher tax rate

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. HMRC statistics show the number of higher rate taxpayers for 2023/24 growing over 40% since 2020/21.

While taxpayers will want to minimise their liability, one problem is that many simply do not have any spare funds to lock away in tax planning measures.

For those 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 the income tax burden.