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Recent months have seen people rushing to take advantage of competitive savings rates, which have ticked up recently amid expectations that the Bank of England will raise the base rate in 2026.
But a bigger savings pot means that you may push past your tax-free allowances, leaving you with a surprise tax bill.
If you’re worried about being hit by tax on your savings returns, or you’re looking to get started saving, it’s useful to understand how savings allowances work, and how you may be able to use Individual Savings Accounts (ISAs) to potentially reduce the amount of tax you have to pay.
Do I have to pay tax on my savings?
Everyone has a basic Personal Allowance, which is the amount you can earn in income each year before paying tax. This is set at £12,570 in the current 2026/27 tax year. However, most people who are working or supporting themselves through a pension will exceed their Personal Allowance through their salary or pension drawdown, so your Personal Allowance will likely only cover your savings if they are your sole form of income.
Most people also have what is known as a Personal Savings Allowance, which is different to a Personal Allowance, and applies to your savings and investments exclusively. This lets you earn a certain amount of income from your savings and investments without having to pay tax on it.
Basic rate taxpayers have a yearly Personal Savings Allowance of £1,000, while higher rate taxpayers get a £500 Allowance. Additional rate taxpayers do not receive a Personal Savings Allowance.
If you exceed your Personal Savings Allowance, then you’ll usually pay income tax on any returns your savings make in excess of your Allowance. If your returns are big enough, they may even push you into a higher tax bracket when combined with your other income, so it’s well worth keeping a close eye on all of your sources of income and the amount of tax you’re paying on them.
If you’re on a low income, you can also earn interest tax-free through what’s known as the starting rate for savings. It’s an allowance that means you can receive up to £5,000 a year in savings interest without paying tax. However, every £1 you receive from income sources that aren’t savings reduces your starting rate allowance by £1. This means that If you earn less than £18,570 a year from income and savings interest, your savings interest could be tax-free.
How can I protect my savings from tax?
One way that you may be able to make significant savings returns without having to pay tax on them is to open an Individual Savings Account (ISA).
An ISA is essentially a tax-efficient wrapper for your savings and investments. Any returns you generate from savings or investments in an ISA structure aren’t subject to income tax or capital gains tax. So, if there is an ISA available offering a similar rate to one of your savings accounts, and your returns are likely to exceed your Personal Savings Allowance, you may be able to get more bang for your buck by transferring your savings into it.
However, you should be aware that you have an annual allowance that limits the amount you can deposit into your ISAs each tax year. This is currently set at £20,000 in the 2026/27 tax year, although the amount that can be saved into cash ISAs will fall from £20,000 to £12,000 from April 2027. Savers aged 65 and over will be exempt from this reduction.
With the tax savings from an ISA factored in, you could potentially stand to earn more after tax even if the ISA pays a lower rate than your usual savings account.
For example, say you have a regular savings account paying 3.5% interest and an ISA paying 3.3% interest. Let’s imagine that you have £20,000 in both, and ignore other allowances for the time being.
Assuming the interest rates held and paid out after a year, your regular savings account would generate £700 before tax, and your ISA would generate £660. However, after deducting the basic rate of income tax (20%) from your £700 return (£140), you would be left with just £560, making the ISA (which is not taxed) more profitable.
Of course, this is a very simplified example, and ignores your Personal Savings Allowance. In practice, you could try to take advantage of both your Personal Savings Allowance and your ISA allowance in conjunction to optimise your savings.
What are the different types of ISA?
There are three main types of ISA, and the right one for you depends on your circumstances, attitude to risk and your age. You don’t have to choose just one type however – you can split your allowance across the different types, or you can choose to put your money into two or more of the same type of ISA if you want to.
Cash ISAs
A cash ISA is a simple tax-efficient savings account and you can choose between easy access cash ISAs and fixed rate cash ISAs.
Easy access cash ISAs usually allow you to make withdrawals whenever you want, whereas fixed rate ISAs often pay slightly higher rates of interest if you are happy to lock your money away for a set period of time. Early withdrawal can come with interest penalties, so make sure you think carefully about when you’ll need to get your hands on your cash.
You can find current best buy cash ISA rates in our article Best cash ISA rates – which cash ISAs pay the most interest? which is updated weekly, or find out more about cash ISAs in our article How cash ISAs work.
Stocks and shares ISAs
With a stocks and shares ISA, sometimes known as an investment ISA, you can put your money into a wide range of investments including collective investment funds, Exchange Traded Funds (ETFs), investment trusts, gilts and bonds and of course, stocks and shares.
This means taking on more risk as the value of investments can go down as well as up, but over long time periods, stock market gains typically outweigh those achieved by cash accounts.
Most people starting out with stocks and shares ISAs tend to choose investment funds, where your money is pooled with that of other savers and invested by a fund manager.
It can be a good way to spread the risk of investing as if one or more companies you invest in fail, there is a chance that gains from other companies in the fund may more than offset these losses.
Innovative Finance ISAs
The Innovative Finance ISA (IFISA) was launched in 2016, allowing savers to earn returns by making loans through peer-to-peer lenders.
This type of ISA matches up people who have money they’re willing to lend with borrowers who perhaps need a loan to pay for a new car, holiday or home improvements, or to fledgling businesses needing cash to expand their operations or purchase equipment.
However, while the returns offered can appear very attractive, these are not guaranteed and there are several big risks to consider, most importantly that the business, individual or project you lend to cannot meet their repayments. Many peer-to-peer lending sites have contingency funds, which are designed to protect investors if this happens, but it’s well worth checking exactly where you might stand if a borrower does default on their payments.
It’s worth noting too that the Financial Services Compensation Scheme (FSCS), which pays savers up to £120,000 if a savings provider goes bust, doesn’t protect peer-to-peer investors in the same way. This means that investors could potentially lose their money if they’ve invested in a business that subsequently runs into financial difficulties.
Doing your homework and finding out what individual firms offer if something does go wrong is crucial. Experts generally suggest only holding a small amount of your savings and investments in this type of ISA, because of the risks involved.
Learn more about ISAs in our article Everything you need to know about ISAs or visit our ISAs explained section to learn more about the different types of ISA.
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