20 July 2023
The Bank of England (BoE) has implemented 13 consecutive base interest rate hikes since December 2021, bringing the rate to 5% as of June 2023.
As we explore in our blog concerning interest rates, rising inflation has prompted the BoE to implement these base rate increases in an attempt to slow consumer spending.
Sadly, this strategy has not been as effective as the BoE may have hoped, as the Office for National Statistics (ONS) reports that inflation was 7.9% in the year to June 2023. This means there could be even more interest rate hikes before the end of the year.
Amid the media noise surrounding the BoE’s latest interest rate decisions, there is one key factor that you might have missed: the Personal Savings Allowance (PSA).
Keep reading to find out what the PSA is, and why the BoE’s interest rate increases could put your wealth at risk of surpassing it.
The Personal Savings Allowance limits how much interest you can earn without paying Income Tax
While rising interest rates could make borrowing money more expensive, there is one notable perk your wealth could experience too: an uptick in the interest paid on your cash accounts.
Indeed, if you noticed your cash receiving little interest during the pandemic, this is because the base rate was reduced to 0.1% in order to encourage borrowing. Now that the base rate has reached 5%, you could find your cash savings are earning substantially more in interest.
For instance, Moneyfacts reports that as of 19 July 2023, you could earn 4.51% interest on an easy access savings account, and more than 5% if you’re willing to wait up to 90 days to access your money.
Importantly, the PSA limits how much interest your cash can receive each year without incurring an Income Tax bill. This applies to most cash savings accounts, with the exception of Cash ISAs – something you’ll read about later in this article.
The PSA for 2023/24 is as follows:
- If you’re a basic-rate taxpayer, you can earn £1,000 a year in interest before paying Income Tax.
- Higher-rate taxpayers receive a £500 PSA.
- As an additional-rate taxpayer, you do not have a PSA.
If you are employed, HMRC will usually change your tax code and add the amount to your Income Tax bill automatically. If you’re self-employed or an additional-rate taxpayer, you should declare the interest earned on your cash savings as part of your self-assessment form.
Working with a financial planner can help ensure you declare your income accurately.
If a large portion of your wealth sits in cash, you could pay increased Income Tax while interest rates are high
Keeping large amounts of wealth in cash can have some drawbacks. One particular downside could be that while interest rates are increasing, the interest earned on your cash savings may push you above the PSA threshold.
For instance, if you pay higher-rate (40%) Income Tax, your PSA stands at £500.
If you had £50,000 in cash between March 2020 and March 2021, and your cash interest rate fell to 0.1% in line with the base rate, your money would have returned approximately £50 in interest for that whole year – far below your £500 PSA.
On the other hand, if these savings held a 4% interest rate for an entire year, you’d earn around £2,000 in interest. While this is positive news overall, £1,500 of this sum would be subject to Income Tax at your marginal rate.
Add this to your existing Income Tax bill, and this interest could even push you into a higher tax band.
So, while rates remain high, it is essential to keep tabs on how much interest your cash savings are earning on a monthly and annual basis.
2 easy ways to restructure your finances if your cash interest is set to breach the PSA
If you anticipate that your annual interest rate will push your earnings above the PSA, there are a few different routes you can take to help prevent this.
Remember: there is no guarantee that your cash savings will be entirely protected by using these strategies. Working with a financial planner could give you valuable peace of mind in this area.
- Open a Cash ISA
Cash ISAs work similarly to easy access savings accounts, except that they are not subject to the PSA.
This means that you could earn more than £1,000 in interest without increasing your Income Tax bill, as long as the interest is paid into your Cash ISA.
So, if your cash largely sits in easy-access or current accounts, placing it into a Cash ISA could be constructive. You can pay up to £20,000 across all the ISAs you hold in any given tax year – so you could potentially send £20,000 straight into one of these handy “tax wrappers”.
2. Reroute some of your cash savings into your investment portfolio
While it is important to have some of your wealth in cash, rerouting some of this money into your investment portfolio could be helpful long-term.
We usually recommend that investments are made over a minimum of five years. So, maintaining a healthy cash savings pot is essential for emergencies and general spending – but beyond this, investing your wealth could help you avoid overstepping the PSA.
Gains on any non-ISA investments you make will likely be subject to Capital Gains Tax (CGT) , although you can make use of your CGT annual exempt amount to offset these gains. The rates of CGT are also lower than the rates of Income Tax.
Investing can grow your wealth sustainably over the long term, so you can feel confident about your financial future in the decades to come. A financial planner can help you design a portfolio that suits your appetite for risk and desired investment time frame.
Get in touch
Are the current high interest rates putting your cash savings at risk of breaching the PSA? Get in touch. Email firstname.lastname@example.org or call 0161 8080200.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate tax advice.
All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.