Pensioners set to pay £2.5billion in savings tax this year in a stealth tax grab

Pensioners are set to pay £2.5billion in savings tax this year as frozen thresholds drag more households into the net, This is Money can reveal.

The savings tax burden for those over 65 years old is set to soar 215 per cent this financial year when compared with the savings tax haul from 2022-23, data from HM Revenue and Customs (HMRC) shows.

The official figures – obtained by Paragon Bank via a Freedom of Information request and shared exclusively – make grim reading for pensioners who have worked hard to build a sizeable emergency fund to enjoy in their late years.

Households have an annual amount they can earn in savings interest which is tax-free which is called the personal savings allowance and is based on their income tax band.

But bands have been frozen since 2022 and the personal savings allowance has been untouched since it was introduced nine years ago.

As earners are pulled into higher tax bands due to these frozen thresholds, not only do they lose more of their income, their personal savings allowance is also reduced which allows the Exchequer to rake in more money in a stealth tax grab.

And although savings rates have dipped over the last year after several cuts to the Bank of England base rate, rates are still far higher than they were in the depths of the pandemic.

This means that although savers are earning stronger interest on their hard-earned cash, they are more likely to breach their personal savings allowance.

If you are a basic rate taxpayer, your personal savings allowance is £1,000.

This means you can earn £1,000 of savings interest each tax year before you start to pay tax.

Any interest earned over £1,000 will be taxed at a rate of 20 per cent, until your total income reaches £50,270.

Once someone's total income goes above £50,270, they pay 40 per cent higher-rate tax.

Higher rate taxpayers only get a personal savings allowance of £500.

Any more than £500 of interest earned on savings will be taxed at a rate of 40 per cent.

Once earnings go above £125,140, earners pay 45p additional-rate tax.

Crucially, once you hit this income bracket, your personal savings allowance disappears completely so all savings interest will face 45 per cent tax.

If you keep your savings in an account paying 4 per cent, a basic-rate taxpayer can have £25,000 saved before breaching their personal savings allowance.

For a higher-rate taxpayer, anything over £12,500 will tip you into paying tax while for additional-rate taxpayers, you’ll need to hand over a chunk of all savings interest to the tax office.

Basic rate taxpayers aged over 65 handed over £197million to the taxman in 2022-23 but this will surge to £518 this tax year. For older higher-rate taxpayers, the tax burden has climbed from £328million just three ago to £885million this year, the Paragon Bank FoI reveals.

However, a sharp hike in savings tax stumped up by additional-rate earners is the main driver in the rise in the total amount paid by those aged over 65.

Tax receipts are expected to more than quadruple for this demographic – surging from £270million in 2022-23 to £1.1billion in 2025-26 – as the removal of the personal savings allowance takes its toll.

Andrew Wright, head of savings at Paragon Bank, said: ‘We’re witnessing a significant and rapid escalation in the tax burden on savers nearing or enjoying retirement. This could have a profound impact on their long-term financial wellbeing.’

But tax receipts from savers under 65 are also expected to rise sharply, up 186 per cent from £1.24billion to almost £3.6billion over the same period.

The tax burden for those of working and and retirees alike could soon soar further if Chancellor Rachel Reeves in the autumn decides to slash the tax-free allowance for cash individual savings accounts (Isas).

She was set to cut the allowance to as little as £4,000 in July but made a last-minute U-turn following outrage from campaigners.

But the Chancellor has allegedly not dropped the plans entirely and Isa reform is still on the cards as the Exchequer wants ‘better outcomes for both savers and for the UK economy’.

If the chancellor does cut the cash Isa allowance in the autumn then the tax burden will simply continue to grow in the coming years as savers swap tax-free Isas for taxable accounts.

Any potential changes will be designed to push savers into investments which in turn are hoped to boost the UK economy.

But unless Britain's investment culture and financial education dramatically changes in a just a few months, it’s likely many households will simply continue to save in cash.

Critics say any potential changes to the cash Isa allowance will not only be designed to champion UK investments but will also boost the Treasury’s coffers as savers put their money in taxable savings accounts instead.

Swathes of readers have told This is Money and the Daily Mail they will continue to keep their money in cash instead of opting for risker investments – whether that’s in traditional savings accounts or ‘under the mattress’.

Savings interest is paid before tax, so to work out if you will end up taxed you should add up all your interest over a tax year and see how it compares to your personal savings allowance level.

If you’re employed or get a pension, HMRC should automatically update your tax code to collect any tax on savings interest, so you pay the tax automatically. You will not need to notify the taxman that you owe tax on your savings interest.

To decide your tax code, the taxman will estimate how much interest you’ll get in the current year by looking at how much you received in the previous year.

But you will need to tell HMRC about savings interest if you complete a self-assessment tax return and it will then calculate what you owe.

Among reasons people have to fill in self-assessment forms are: if HMRC tells them they need to, if they earn more than £150,000, or they are self employed.

If your income from savings or investments is more than £10,000 then you need to register for self-assessment.

If you are not employed, do not get a pension or do not complete self-assessment forms, your bank or building society will tell HMRC how much interest you received at the end of the year. HMRC will tell you if you need to pay tax and how to pay it.

The main way to avoid paying tax on your savings is to use an Isa. This could be a cash Isa – which is free of savings interest – or a stocks and shares Isa – which is free of dividend and capital gains tax.

You have up to £20,000 a year to channel into these tax-free vehicles.

Like normal savings accounts, you can funnel your money into easy-access Isas and fixed-rate Isas of different terms.

Better yet is a flexible Isa, which allows you to withdraw your money and, crucially, put it back again without affecting your annual allowance – provided you pay it back in the same tax year.

Flexibility is a useful feature to have in an Isa when it comes to keeping as much of your savings tax-free as possible.

Savers with larger pots and who can max out their £20,000 Isa limit will see the most benefit from a flexible Isa.

Mr Wright said: ‘Isas remain an accessible and flexible option, empowering savers to protect more of their hard-earned money and make the most out of their nest eggs as they plan for, or live through, retirement.’

But don’t forget Premium Bonds from Treasury-backed bank National Savings and Investments. Holders can invest between £25 and £50,000.

Instead of a regular interest payment, each £1 Bond is entered into a prize draw every month and winners receive prizes from £25 to £1million. Crucially, winnings are tax-free – and you never lose your original stake.