When interest rates rise, many savers look forward to earning more from their money.

However, higher interest rates can sometimes have unexpected side effects.

Recently, HMRC has been issuing warnings to savers who keep their money in savings accounts, as the interest they earn may push them over their Personal Savings Allowance, potentially costing them more in tax than they expected.

In this article, we will explain the HMRC warning on savings accounts, the difference between a Personal Allowance and a Personal Savings Allowance, and outline three types of savings accounts that can help you save your money more efficiently.

Sheffield Mutual are not tax experts. Whenever you’re preparing a savings strategy, it’s essential to understand whether tax will need to be paid on any interest or bonuses you earn. This blog is based on our current understanding of tax legislation. Tax treatment depends on individual circumstances and may change in the future. If you have any tax questions, you should speak to a tax expert, which may incur a fee.

Personal Allowance vs Personal Saving Allowance

Although they share the same name, Personal Allowance and Personal Savings Allowance are very different.

Personal Allowance

Your Personal Allowance is the amount you can receive as income every year before any tax is due to be paid. Although this can vary by circumstances, the UK Personal Allowance is currently £12,570 for most residents, meaning they can receive up to this amount of income before paying tax.

Personal Savings Allowance

Your Personal Savings Allowance is a separate amount that determines how much interest you can earn before you need to pay tax on it as income. The Personal Savings Allowance for UK residents is dependent on your tax band, and is as follows:

• Basic Rate: Can earn up to £1000 in interest before paying tax

• Higher Rate: Can earn up to £500 in interest before paying tax

• Additional Rate: Additional rate taxpayers cannot earn any interest on standard accounts without paying interest.

It’s important to note that your Personal Saving Allowance is only utilised once your Personal Allowance has run out. If you earn over £1000 in interest but your overall income remains below £12,570 per annum, for example, there is still no tax to be paid.

Will This Affect My Pension?

Due to the triple lock, the value of the state pension has been increasing year on year. However, the Personal Allowance has remained the same, meaning the current state pension, £12,547.60, is approaching the £12,570 limit for the Personal Allowance.

This means that, if you are receiving the state pension, you can earn £22.40 before you reach your Personal Allowance. By extension, this means that a pensioner receiving only the state pension could earn a maximum of £1,022.40 in interest before paying tax.

What Savings Accounts Can Help Me Protect My Personal Savings Allowance?

There are a variety of tax-efficient accounts that can enable savers to earn interest on their money without paying additional tax. These types of savings include:

• ISAs

• TESPS

• Premium Bonds

ISAs

ISAs are one of the most popular tax-efficient savings accounts in the UK. Every tax year, the Government sets an annual ISA allowance, which determines how much can be contributed to an ISA. For the current tax year, this limit is £20,000.

A real advantage of ISAs is their diversity. There is a range of ISA types, including Cash ISAs, Stocks and Shares ISAs, Lifetime ISAs, and Innovative ISAs.

At Sheffield Mutual, we offer a variety of ISAs, so our members can choose the savings account that is right for them.

If you have a lump sum you want to invest, like an inheritance or unexpected windfall, consider our Single Premium Investment ISA, which allows you to make a one-off contribution to your ISA with the aim of watching your money grow. If you find any extra money later, you can still add this to your ISA, as long as contributions don’t exceed the £20,000 limit. 

If you prefer to make regular contributions to your ISA, consider our Regular Premium Investment ISA. This ISA is designed to receive regular contributions to be most effective, although contributions can be paused, stopped, started, increased or decreased in line with your circumstances.

If you are interested in sustainability, our Sustainable ISA may be the right product for you, letting you rest easy knowing your savings are invested in companies with strong principles.

TESPs

Tax Exempt Savings Plans, or TESPs, are a type of savings plan exclusive to friendly societies like Sheffield Mutual.

A TESP increases the value of your savings in two ways: first, when taking out a TESP, you will receive a ‘Sum Assured’, which is the minimum amount that you will receive when your plan reaches maturity, guaranteed to be higher than the value paid in as long as you contribute for the full length of the plan.

In addition to the sum assured, your TESP can receive additional bonuses in line with fund performance. This means that the better these investments perform, the more money you can earn as bonuses, without incurring tax. It is important to note, however, that investments can fall, so bonuses cannot be guaranteed.

In addition to the sum assured and bonuses, TESPs also provide an additional benefit through a process called ‘smoothing’. In years where the fund performs well, some of the surplus profits are held back. Then, in years where the fund does not perform as well or during periods of economic uncertainty, these funds can then be used to reduce the impact of poor market conditions.

Premium Bonds

Premium Bonds are a product exclusive to NS&I. Unlike a TESP, Premium Bonds do not offer a guaranteed return. Instead, they offer bondholders the chance to win prizes ranging from £25 to £1,000,000 every month.

Instead of earning interest, investing in Premium Bonds enters you into an annual prize fund rate that funds a monthly prize draw for tax-free prizes. However, because no prizes are guaranteed, it can be difficult to build a financial strategy around Premium Bonds as there is no guaranteed minimum return.

Explore Your Savings Options With Sheffield Mutual

As a friendly society, Sheffield Mutual provides a range of tax-efficient savings options for its members.

If you are interested in opening a TESP or an ISA, please contact us, and a member of our friendly, helpful team will be happy to talk you through your options and help you discover the best savings options for you.

This blog provides generic information and the writer's opinions and should not be relied upon for investment decisions. Sheffield Mutual has provided no advice. If you doubt whether a savings or investment plan suits you, consider contacting a financial adviser for advice. If you do not have a financial adviser, you can get details of local financial advisers by visiting www.unbiased.co.uk or www.vouchedfor.co.uk. Advisers may charge for providing such advice and should confirm any costs beforehand.