Do you need to do a tax return for your savings? - Which? News (2024)

In previous years, only those with the biggest nest eggs had to worry about paying tax on savings interest. But record-high rates over the past two years mean a rising number of savers with modest pots are now being landed with an unwelcome bill from HMRC.

In November 2023, we surveyed 508 people who will be submitting a self-assessment tax return for the 2022-23 tax year. We found 20% are filing because they owe tax on savings interest or investment income.

Separate research by Paragon Bank also found that nearly a third of those breaching their personal savings allowance (PSA) – the amount of annual interest you can earn tax-free – are doing so for the first time.

With the 31 January filing deadline fast approaching, Which? explains what savers need to know about tax on interest.

Which? tax calculator

Our jargon-free tool can help you tot up your tax bill and send your tax return directly to HMRC.

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What tax do you pay on savings?

Rising interest rates since 2021 have led to a surge in people opening a savings account, but anyone who has invested a large lump sum should check whether they owe any tax for 2022-23.

The PSA, a tax-free allowance that shields a portion of savings interest from income tax, currently stands at £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Additional-rate taxpayers do not have a PSA, meaning all their savings interest is liable to income tax.

But the balance required to exceed the PSA has shrunk considerably in recent months, thanks to rising savings rates. The best one to two-year fixed-term account currently offers around 5% AER. It means a basic-rate taxpayer would need a balance of just over £20,000 to breach their PSA, but a higher-rate taxpayer would only need £10,000 in their account before they had to start paying tax on interest.

In Paragon Bank's survey of 1,700 savers, rising interest rates were cited by 43% of those who breached the PSA. However, increased saving balances also played a role, with 22% of respondents attributing their PSA breach to this factor.

• Find out more:tax on savings interest and investment income

What happens if I exceed my allowance?

Any interest that exceeds your PSA, will be charged at the same rate of income tax as your wages.

If you're employed, HMRC will automatically collect the tax you owe through pay-as-you-earn (PAYE), usually by tweaking your tax code.

But if you're paying your tax using self-assessment, then it's your job to report your savings income as part of your tax return, even if it is less than the PSA.

Banks and building societies send savings interest data to HMRC after the end of the tax year. The tax office will then use that information to estimate how much tax you owe and then check the figure you declare on your return matches.

What if you've paid too much?

If you find you've paid too much tax on your savings interest, then you might be able to claim it back from HMRC – either via self-assessment or, if you're employed, by filling in an R40 form.

Remember, if you think you made a mistake after submitting your tax return, you can correct it within 12 months of the self-assessment deadline – either online or by sending another paper return. If you need to make a change to a return from an earlier tax year, you’ll need to write to HMRC. You can claim tax back on savings from up to four tax years ago.

It normally takes around six weeks to get your money back.

Ways to reduce your savings tax bill

Open an Isa

Putting money in an Isa means you can save up to £20,000 a year tax-free. Savers can deposit the full allowance into a cash, stocks and shares or innovative finance Isa, or any mix of the three types.

While you're currently only allowed to pay into one cash Isa account in each tax year, new rules that come into force from April will enable savers to easily move between different providers in search of higher returns.

• Find out more:best cash Isas 2023

Split and save

Another strategy is to diversify your investments. Splitting funds into several fixed-rate accounts of varying terms means you can spread out the interest payments and reduce your tax bill.

For example, a large lump sum could be distributed evenly across one, two, three, four and five-year fixed-term savings accounts. If you choose to have the interest paid upon maturity, then the income earned on your nest egg will also be spread across several different tax years and won't take such a big bite out of your PSA.

• Find out more:how to find the best savings account

Premium bonds

You can hold up to £50,000 tax-free in premium bonds and while they don't pay any interest on the money you save, every month you'll be entered into a prize draw with a chance of winning anything from £25 to £1m.

However, it's worth bearing in mind that for every millionaire jackpot winner there will be many, many people not winning anything at all. It really is the luck of the draw.

• Find out more:premium bonds – are they worth it?

Starting rate for savings

Lower-income savers may benefit from this tax break, which currently allows you to earn up to £5,000 in savings income, tax-free. However, to be eligible you'll need to be earning less than £17,570 from other income sources. If that's you, here's how it works.

Every £1 of other income (for example your wages or pension) above your personal allowance of £12,570 reduces your starting rate for savings by £1. So, let's say you earn £15,000 a year. You'd have £2,430 of taxable income and your starting rate for savings will be reduced by the same amount. After deducting that from the £5,000 cap, it means you can earn up to £2,570 in interest without paying a penny in tax.

Get help with your tax return

If you haven't yet submitted your 2022-23 tax return, the Which? tax calculatorcould help.

Our online tool is easy to use, jargon-free and helps you calculate your tax bill. What's more, it will even suggest areas where you could be able to claim expenses that you might have forgotten about.

When you're finished, you can use the tool to submit your tax return directly to HMRC.