Paying tax on your savings? Make sure you check HMRC’s sums

As interest rates have risen, millions of savers now need to consider whether they might have tax to pay on their savings income. In many cases, HM Revenue and Customs will do the sums required, but it is not a perfect system and savers would be wise to check their position to avoid the risk of penalties. 

Until this year, most savers will not have needed to give tax much thought. Between low interest rates, the tax-free “savings allowance”, and the ability to earn tax-free interest using Isas, only those with significant savings were likely to have a liability. 

Now, with interest rates in the region of 5pc – having risen beyond 6pc earlier this year – savings of £20,000 from cash held outside Isas could quickly start to generate returns in excess of tax-free savings allowances. 

A freedom of information request obtained by investment platform AJ Bell suggests that up to 2.7 million people will need to pay tax on savings income in the current tax year. 

How will I know if I owe savings tax?

Those who file self-assessment tax returns will already be familiar with having to report their interest annually, but anyone who doesn’t may be worried about how to declare any tax due on their interest. HMRC’s guidance reassuringly says that only those with interest of over £10,000 need to go into self-assessment purely because of their savings income. 

For everyone else, HMRC’s position is broadly “don’t call us, we’ll call you”. However, this approach on interest is based on the effective operation of a massive data-matching exercise. While this does work for many people, savers should take care that they don’t fall through the cracks. 

Savers also need to be aware of significant changes to the taxation of interest which occurred during the long period of low rates. 

Since April 6, 2016, banks and building societies have paid interest gross – ie. without any deduction of tax. At the same time, everyone was given a “savings allowance”. This is effectively an amount of interest you can earn tax-free each year. 

For those with taxable income (including interest) of under £50,270, the allowance is £1,000. The allowance is halved to £500 if your income exceeds £50,270 – and removed entirely once your annual income goes over £125,140 (or £150,000 for 2022-23). 

Further measures allow those with income of less than £17,570 to benefit from a special 0pc tax rate on up to an additional £5,000 of interest. This allows those on lower incomes to keep more of their savings interest.

Each year HMRC gets a list from banks and building societies of the interest they have paid out. HMRC then does a massive data-matching exercise with around 100 million accounts each year. 

As long as HMRC can match the details from your bank to your record, it can look at your employment and pension income – plus any other information it has – to produce either a tax calculation letter (often referred to as a P800) or a Simple Assessment. 

If you get a P800, HMRC will adjust your PAYE code to collect any tax owed on your interest from future salary or pension income. A Simple Assessment is a bit like a tax return, only HMRC completes it for you, based on the information it holds. If the information is correct, you need to pay the sum demanded by the date on the letter. 

Whichever you get, check the figures HMRC has used. We have had reports of savings accounts being omitted or duplicated. Confusion can also arise if one of the account signatories has a power of attorney but no ownership of the funds.

HMRC also won’t know – and therefore needs to be told – about interest earned from government bonds, peer-to-peer lending or on investments like open-ended investment companies (OEICs), investment trusts and unit trusts.

Do I need to contact HMRC?

Those who think they will have tax to pay for 2023-24 can sit tight for the time being. HMRC won’t be in touch until that reconciliation process is completed, which is likely to be between July and October 2024. 

Savers can pre-empt matters by contacting HMRC with their details after April 5, 2024, but be warned that HMRC is unlikely to have the resources to handle direct contact from all 2.7 million savers, and will be relying on automation to do the heavy lifting.  

In contrast, those who know they have exceeded their savings allowance in the last tax year (2022-23) but who have not yet heard from HMRC, need to take urgent action as it is possible the matching system has not worked for them. 

Although current guidance from HMRC says it will handle it, the responsibility for paying tax ultimately lies with the taxpayer. It would be wise to contact HMRC by phone or post, armed with a list of your bank accounts and the interest earned on each. Otherwise, HMRC may charge interest and penalties down the line on any unpaid tax.