Taxes and savings

What is the difference between a bank and a building society?

Your money may earn interest if you deposit it in a bank or building society account. Interest is money paid by a bank or building society to you in exchange for their holding (and using) your money.

For tax reasons, interest is considered income on the day it is credited to your account. The majority of bank and building society earnings are taxed.

Normally, we think of 'income' as something that is 'earned,' such as from a job or self-employment, but interest from a bank or building society is a sort of passive (or 'unearned') income. It is not taxed the same way as earned income.

How is interest paid by banks and building societies taxed?

The 'personal savings allowance (PSA) of £1,000 (or £500 for higher rate taxpayers) means that most people will pay no tax on interest received from a bank or building society account. PSAs are not available to additional rate taxpayers. The PSA went into effect on April 6, 2016.

Savings income that goes into your PSA is tax-free, which means you don't have to pay any taxes on it.

Unless the income is particularly tax-free, the basic rate of 20%, the higher tax rate of 40%, or the additional rate of 45 percent may apply after the PSA. When determining which rate band may apply to your savings income, keep in mind that, with the exception of dividend income, saves income is classified as the top slice of taxable income.

See Henry for a basic example of how the PSA works.

If you are a Scottish or Welsh taxpayer, you must pay tax on your savings income according to UK rates and bands. See below for details on how the PSA affects Scottish and Welsh taxpayers.

Note that income within your PSA is taxable (albeit at 0%), and thus counts towards your basic or higher rate limits – and thus may affect things like the amount of PSA you are entitled to in the first place, the rate of tax due on any savings income you receive in excess of this allowance, and the rate of tax you pay on dividend income (for more information, see What tax rates apply to me?). Consider Magda's case.

Furthermore, the income is regarded as income for tax credit reasons because it is still taxable income (albeit taxable at 0%). Actual income is ignored for universal credit purposes, and if your total savings surpass a specific threshold, you are considered to have 'tariff' income. See our universal credit page for additional information.

Please keep in mind that the PSA is in addition to the standard personal allowance and the savings rate (£5,000). Even without the PSA, anyone with a total taxable income of less than £17,570 (for example, from wages, profits, pensions, and savings – not counting dividends) will normally pay no tax on the bank or building society interest in 2021/22. If you receive a blind person's allowance, marriage allowance, or a married couple's allowance, the £17,570 number may be greater.

What happens if I have to pay tax on the interest I earn on my savings?

Because of the PSA, most people who earn interest from banks and building societies will not have to pay tax on their savings income. Bank interest is not taxed at the source by banks or building societies, and it is paid gross.

Because of the PSA and the fact that banks and building societies do not deduct tax at source, the tax situation for most people with small amounts of savings income is simple and, in the vast majority of situations, correct. Others, on the other hand, maybe required to notify HMRC of their untaxed, taxable savings interest.

If you are required to pay tax on your bank and building society interest and you regularly file a tax return, you can add the amount of savings income in the appropriate area.

If you don't regularly file a tax return, you must notify HMRC of any taxable income by the 5th of October after the end of the tax year in which it occurred (so 5 October 2022 for the tax year ending 5 April 2022). Hmrc will deduct the additional tax you owe from your wages if they can by changing your Pay As You Earn (PAYE) code. They may issue you a bill at the end of the tax year or ask you to fill out a tax return if they are unable to alter your tax code.