A few days ago, the Bank of England held interest rates at 5.25%, currently at its highest level for 16 years.

The interest rates affect mortgage and credit card payments for millions of people across the UK. But it also means that you’re more likely to be paying tax on the interest income you’ve accrued.

Let’s take a look at the impact of higher interest rates on your savings income and tax liabilities.

What is the personal savings allowance?

Most of us can earn up to £12,570 from any source without paying tax. Separate from (and in addition to) this income allowance is the personal savings allowance.

The personal savings allowance shields from tax interest income of £1,000 for basic rate taxpayers. This shielding is reduced to £500 for higher-rate taxpayers, and falls away altogether for additional-rate taxpayers.

How will rising interest rates affect my taxable income?

When interest rates were low, even people with quite sizeable savings didn’t need to consider paying tax on the interest earned. But as rates have increased, more taxpayers are going over the shielding threshold and are having to pay tax on their interest income.

This effect has been exacerbated by the freezing of tax thresholds, effectively pushing more people into the higher-rate and additional-rate tax brackets, where the personal savings allowance reduces or falls away.

What about if I have my savings in an ISA?

It’s worth noting that interest earned in cash ISAs (Individual Savings Accounts) is tax-free.

As a UK taxpayer, you can invest up to £20,000 per annum into an ISA. Although traditionally the rate of interest earned has been lower than that available elsewhere, the tax saving will affect the relative return. The funds are generally available to be withdrawn at any time.

Talk to us about mitigating the tax on your savings interest

Tax is only one of the considerations when looking at investment strategies. If you have surplus funds, simply putting them into the bank to earn interest may not be the best choice.

As an accounting firm, we cannot advise on investment strategies. But if you want to discuss your savings plans with an independent financial adviser (IFA), talk to us and we’ll arrange an introduction. IFAs will be able to give advice tailored around your specific circumstances and needs, and with the best possible outcomes when it comes to mitigating tax.