How safe are your savings? 5 ways to avoid the interest tax trap

A combination of rising interest rates and frozen tax allowances has proven to be a double threat for savers, with an increasing number of people forecast to paying tax on their savings interest.

According to MoneyWeek, the rising tax burden means savers over 65 are expected to pay £2.5 billion in the 2025/26 tax year, a 215% increase on 2022/23.

This strain on older savers can be tough, especially if you’re approaching or in retirement and have a carefully designed financial plan.

However, there are steps you can take to mitigate this potential liability. Read on to discover more about how tax applies to your savings interest, and what you can do to protect your wealth.

Interest on savings is taxed after your returns exceed certain thresholds

Putting some money aside into a savings account on a regular basis seems like a sensible idea. Whether you’re saving up for a holiday, a new car, or simply want a “rainy day” fund to fall back on, having some easy-access cash reserves can feel comforting.

However, no one wants to lose their hard-earned wealth through taxation. Savings tax can often catch people out. In fact, according to a study from Lloyds, 24% of UK adults think their savings are tax-free, regardless of the type of account and amount of savings.

While your savings themselves aren’t taxed, you are taxed on interest above a certain amount. This is applied at your highest Income Tax rate.

For the tax year 2025/26, everyone has a tax-free Personal Allowance for all income, including interest, of £12,570.

You could also benefit from the starting rate for savings, allowing you to earn up to £5,000 in tax-free interest. However, for every £1 you earn above your Personal Allowance, your starting rate will be reduced by the same amount.

For example, if you earn £16,000 and receive £200 in savings interest, your starting rate will be £1,570.

This is calculated as follows:

£16,000 – £12,570 = £3,430.

£5,000 – £3,430 = £1,570.

If your income exceeds £17,500, the starting rate for savings won’t apply. However, you may still benefit from the Personal Savings Allowance (PSA). This allows:

• • Basic-rate taxpayers to receive up to £1,000 tax-free interest a year
  • Higher-rate taxpayers to receive up to £500 tax-free interest a year.

Additional-rate taxpayers do not receive a PSA.

All this is to say, if you have no other taxable income, you could earn up to £17,570 in interest before tax is due.

It’s important to note that your tax band is influenced by your savings interest. If you pay basic-rate tax, but your savings income pushes you into the higher-rate band, your PSA reduces to £500.

Changing the way you save could protect you from a tax bill

Fortunately, there are some steps you can take to avoid falling foul of the savings tax trap. Here are five ways to switch the way you save and protect your wealth.

1. Put your money in a Cash ISA

As of 2025/26, you can put up to £20,000 into a Cash ISA annually or spread this allowance across multiple ISAs.

You’ll earn interest in the same way you would in a savings account, but tax-free. Any money you take out of the ISA wrapper will lose its tax benefits, although you won’t lose the tax-free interest already accumulated.

If you choose a flexible ISA, you can withdraw money and put it back in during the same tax year without it counting toward your ISA allowance.

2. Invest in a Stocks and Shares ISA

A Stocks and Shares ISA enables you to make a wide range of investments that reflect your attitude to risk and tolerance for losses. As with a Cash ISA, you can invest up to £20,000 annually. Dividends are made tax-free and there’s no Capital Gains Tax (CGT) to pay on investment returns.

Remember, you can only contribute up to £20,000 across your ISAs in a single tax year.

We generally advocate planning decisions based on known legislation rather than rumours and speculation, However, the approaching budget supports an argument to use your ISA allowances where possible before 26 November 2025, just in case the chancellor lowers allowances.

3. Increase your pension contributions

Returns from pension investments aren’t liable for tax, and in the 2025/26 tax year, you can contribute up to £60,000 (or 100% of your earnings, if lower) without facing an additional tax charge. These payments are eligible for tax relief at your highest rate of Income Tax.

However, money invested in a pension can’t be accessed until you turn 55, rising to 57 in 2028, when you can take up to 25% of your pension as a lump sum. Therefore, you may need to think of this as a long-term savings option.

4. Buy Premium Bonds

While savings in Premium Bonds don’t earn interest, you’ll be entered into a prize draw each month, and winnings are tax-free. These prizes range from £25 to £1 million. However, there’s no guarantee of winning, so this isn’t a reliable method if you want regular returns.

You can put between £25 and £50,000 into Premium Bonds, and can withdraw funds at any time. The more you hold, the more likely you are to win a prize.

5. Save for a child or grandchild

Putting money into a Junior ISA (JISA) can be an effective way to save for your children or grandchildren. You can contribute up to £9,000 in the 2025/26 tax year. There is no tax to pay on interest in a Cash JISA, and investment returns in a Stocks and Shares JISA are free of Income Tax and CGT.

You could also open an ordinary children’s savings account, which is often tax-free. The exceptions here are if the child gets more than £100 in interest from money given by a parent, in which case the parent will have to pay tax on interest above their PSA. The child may also have to pay tax if they have income above their Personal Allowance, such as from a trust.

Get in touch

We’re here to help you make the most of your wealth and can talk to you about a wide range of options for tax-effective savings. Please email us at info@harperlees.co.uk or call 01277 350560 to find out more, and we’ll be very happy to help.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.