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If you want to make sure you don’t end up paying unnecessary tax on your savings income, it’s vital to get to grips with the various tax rates and allowances which apply.
Prior to 2015, there used to be a 10% tax rate on savings income in the UK. However, the 10% savings tax rate was abolished a decade ago and replaced with a 0% starting rate for savings.
Here, we explain how the 0% starting rate works, who it applies to, how and why it’s vital to make the most of your annual ISA allowance if you think you’re likely to have to pay tax on your savings income.
How does the 0% starting rate for savings work?
If your income is low enough, you can earn up to £6,000 (£5,000 from the 0% starting rate for savings and £1,000 from the Personal Savings Allowance) in savings interest without having to pay any tax on it.
You’ll only qualify for the 0% starting rate for savings if the income you have, which doesn’t come from savings (for example, from your salary or pension or any rental income you might earn), is below a certain threshold.
This threshold is your Personal Allowance, which is the amount everyone can earn without having to pay income tax and for the 2025/26 tax year is £12,570. So, for example, if your only income is from the full State Pension, which is £11,973 this year, this would be below your Personal Allowance, so you’d be able to earn up to £5,000 in savings interest without having to pay a single penny in tax on it.
Other scenarios where this could apply:
- You’ve retired early and are living off a modest pension and savings.
- You work part-time and earn under £12,570 annually.
- You’ve delayed drawing a pension or taking a tax-free lump sum, keeping your income temporarily low.
To make matters more complicated, if you’re a basic rate taxpayer paying tax at 20% (so you earn than the £12,570 personal tax allowance but less than £50,270, which is the point at which you start paying higher rate tax) you’ll also get a Personal Savings Allowance of £1,000. This is in addition to the £5,000 starting savings rate, so you’ll effectively be able to earn £6,000 in savings interest without having to pay any tax on it.
Even if you don’t qualify for the 0% starting rate, most people will still benefit from the Personal Savings Allowance. However, this reduces from £1,000 to £500 if you’re a higher rate taxpayer whilst additional rate taxpayers who pay tax at 45% don’t get a Personal Savings Allowance.
What happens if my income is higher than the Personal Allowance?
The £5,000 starting rate band is reduced pound-for-pound by any non-savings income above the £12,570 Personal Allowance, so you may lose the full £5,000 allowance if your income is £17,570 or more.
For example, if you have £12,570 in non-savings income, you get the full £5,000 at 0%. If your non-savings income is, say, £13,570 (so £1,000 over your Personal Allowance), then your 0% savings rate band is reduced to £4,000 and so on.
Once your non-savings income reaches £17,570 (£12,570 + £5,000), you no longer qualify for the 0% starting savings rate.
Example:
You earn £16,000 of wages and get £200 interest on your savings.
Your Personal Allowance is £12,570. It’s used up by the first £12,570 of your wages.
The remaining £3,430 of your wages (£16,000 minus £12,570) reduces your starting rate for savings by £3,430.
Your remaining starting rate for savings is £1,570 (£5,000 minus £3,430). This means you will not have to pay tax on your £200 savings interest.
Source: Gov.uk
How can I reduce my tax bills if I’m not eligible for the 0% starting rate for savings?
The good news is that all savers can make the most of their annual individual savings account allowance, which allows you to shelter up to £20,000 each tax year, with returns free from both income tax and capital gains tax.
However, the government is currently consulting on ISA reforms and certain commentators have speculated that it may reduce the cash ISA allowance in an effort to steer more savers toward investing in the stock market and supporting UK businesses, rather than holding their money in cash accounts.
Some have suggested the cash ISA limit could be cut to £10,000, while others believe it might be reduced even further – possibly to just £4,000. For now, though, the cash ISA allowance remains the same as last year, so you may want to shelter as much of your savings as possible before any potential changes might be announced.
A final thought…
If your total income is below £17,570, it’s well worth checking how much of your savings income might fall under the 0% starting rate. You should then reassess where your savings are held. If your money is in low-interest accounts, for example, consider moving it to higher-interest-paying savings accounts. After all, tax-free interest is only valuable if you’re earning interest to begin with.
If you don’t qualify, then use ISAs wisely. You can find out more about how they work and where to find the best returns in our articles Everything you need to know about ISAs and Best cash ISA rates – which cash ISAs pay the most interest?
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