Higher interest rates can often feel like good news if you hold a significant amount in cash. And, after years of lower returns, you may finally be earning a more meaningful amount of interest on your savings.
However, if you hold large cash balances outside tax-efficient accounts, you could also face a larger-than-expected tax bill.
This is Money reports that an estimated 144,000 people are expected to pay at least £5,000 in tax on their savings interest in 2026/27. This is up from 52,700 in 2022/23.
Continue reading to learn why this is happening and discover some tax-efficient options that could help you keep more of your returns.
Higher interest rates and frozen allowances can increase the tax you pay on savings
You typically pay Income Tax on any savings interest that exceeds your available allowances. This means that when interest rates rise, your tax liability can quickly change.
For instance, if you hold £100,000 in a savings account earning 1%, you would earn £1,000 interest each year. If your rate rose to 4%, you would earn £4,000.
Even though your cash balance hasn’t changed, the amount of taxable interest may have increased significantly.
This is why some who have never thought much about tax on savings may now be affected.
It’s important to note that you can earn some savings interest without paying tax, depending on your income and which allowances may apply to you.
As of 2026/27, your Personal Savings Allowance stands at:
- £1,000 if you’re a basic-rate taxpayer
- £500 if you’re a higher-rate taxpayer
- £0 if you’re an additional-rate taxpayer.
If your savings interest exceeds your allowance, you typically pay tax on the excess at your marginal rate of Income Tax.
This means higher-rate taxpayers may pay 40% on their taxable savings interest, while additional-rate taxpayers may pay 45%.
So, if you hold a large amount of cash, your total bill may quickly add up.
This is Money reports that, at a 4% interest rate, you would need at least £325,000 as a higher-rate taxpayer to create a bill of £5,000 or more, or £277,500 as an additional-rate taxpayer.
You should also note that several key allowances have not increased in line with the returns some people are earning.
The Personal Savings Allowance was introduced in April 2016 but has remained at the same level ever since.
This means that the allowance covers a smaller proportion of your savings interest, even when rates are higher.
Individual Savings Accounts could help shield your savings from tax
One of the more common ways to reduce tax on your savings interest is to use an Individual Savings Account (ISA).
As of the 2026/27 tax year, you can usually save up to £20,000 in all of your ISA accounts.
Then, any interest and investment returns within your ISA are typically free from Income Tax, Capital Gains Tax, and Dividend Tax.
This could be practical if you’re a higher- or additional-rate taxpayer, or if your cash savings are generating enough interest to exceed your allowance.
However, upcoming changes mean it may be worth reviewing how you use your ISAs sooner rather than later.
From 6 April 2027, the Cash ISA allowance for under-65s will fall to £12,000, while the overall ISA allowance will remain at £20,000.
This means the remaining £8,000 will effectively be reserved for other types of ISA, such as a Stocks and Shares ISA.
The government has also confirmed anti-circumvention rules, meaning that, from April 2027, cash held in non-Cash ISAs, such as a Stocks and Shares ISA, can remain there, but any interest earned on that cash will be subject to a flat 22% charge.
The Personal Savings Allowance will not apply to this interest.
So, while ISAs can still play a practical role in reducing tax on savings and investments, you may need to think carefully about how much cash you hold.
Premium Bonds may be useful, but they don’t provide guaranteed interest
Premium Bonds may also appeal if you want to hold cash in a tax-efficient way, as any prizes you win from Premium Bonds are typically free from tax.
You can hold up to £50,000, and your money is backed by the Treasury, making Premium Bonds attractive if your savings interest would otherwise be taxable.
Just note that they aren’t the same as a normal savings account, as Premium Bonds don’t pay interest.
Instead, your bonds are entered into a monthly prize draw. While you might win more than you would have earned in interest, you might also win nothing.
As such, Premium Bonds may not be suitable if you need a predictable return from your savings.
Get in touch
We can review whether your savings are held tax-efficiently and if other options could support your progress towards your long-term goals.
Please email us at info@investmentsense.co.uk or call 0115 933 8433 to find out more.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
The Financial Conduct Authority does not regulate tax planning and premium bonds.
