How to prepare for tax grab on cash returns

It’s no secret that with each passing year our tax bills are getting bigger, but increased revenue in one area of the fiscal framework is particularly striking.

In 2020-21, the Treasury raked in £1.4 billion from savings interest. Fast forward just four years to 2024-25, and that figure is estimated to have vaulted to £10.4 billion – an astonishing jump.

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A few reasons can explain this trend. The main one is that higher interest rates have improved cash returns, which is a good thing. Other drivers, however, are less encouraging. Fiscal drag is pulling more people into higher tax rates, and key tax exemptions haven’t ticked up with inflation.

Despite the direction of travel, there are ways to shield your cash returns from HMRC, although the task will soon get tougher due to a series of policy reforms taking effect in April 2027.

These tax hikes will arrive in various forms, from less generous allowances and higher headline rates to controversial new rules and prolonged frozen thresholds. A further hurdle for savers is that some areas will become more complicated.

Let’s run through what’s changing, flag the important things to know, and examine what you can do to keep more of your hard-earned cash interest.

Headline savings rates increasing

One of the more unexpected measures announced at last year’s Autumn Budget, was the move to increase headline tax rates on savings by two percentage points across the board, from 2027-28. Currently, these are aligned with the income tax system.

Forecasts suggest that this measure, combined with hikes to dividend and property taxes, will pocket the government an extra £2.3 billion a year.

The new rates, which apply to taxable interest that exceeds your personal savings allowance (more on that further down), when added to other income, are as follows:

Below £12,570: 0%

£12,571 - £50,270: 22% (up from 20%)

£50,271 - £125,140: 42% (up from 40%)

Above £125,141: 47% (up from 45%)

Importantly, these increases won’t solely impact money you have in savings accounts or any cash held within a general investing account (GIA). Gilt coupons outside tax wrappers and investment bond chargeable gains will also rise.

Cash ISA allowance cut for under 65s

The government wants to encourage more people to invest rather than save and feels squeezing the tax advantages of ISAs is one route to achieve this goal.

Unless you’re 65 or older at any point during the next tax year, the amount you can shove into cash ISAs will drop from £20,000 to £12,000.

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The overall £20,000 allowance will remain, meaning to maximise your annual limit you’ll need to stick at least £8,000 into a stocks and shares or innovative finance ISA.

Tax on uninvested cash within a stocks and shares ISA

To deter savers from gaming the new rules, the government is introducing a 22% tax charge on interest paid on uninvested cash inside a stocks and shares ISA. The rules are yet to be fully confirmed, but under current proposals the charge will also apply if you allocate 100% of your portfolio to money market funds (a cash-like asset).

And unless you’re 65 or older, transfers from a stocks and shares ISA to a cash ISA will be prohibited.

Tax thresholds and savings allowance to stay frozen

Some tax increases on cash holdings will take a less obvious form.

Income tax thresholds have been frozen since 2021, a covert way to boost Treasury coffers without jacking up the headline rates as millions more people are being pulled into higher tax bands as incomes naturally rise over time.

Unless the new chancellor decides to end fiscal drag, as its known, at this year’s Autumn Budget, the current bands will be unchanged for 2027-28. The upshot is that taxable savings interest could trip you into an upper tax bracket or perhaps even land you in a tax trap, exposing you to an even bigger HMRC bill. In some cases, you could even be worse off.

In addition, the savings allowance - the amount of interest you can earn every year tax free - will also stay put, and in fact hasn’t budged since it was introduced in 2016.

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Four tips to keep HMRC at bay

So, above we’ve outlined what’s changing, but the question is, what can you do to protect your cash holdings? Here are some useful considerations.

1) Understand how the personal savings allowance works

As noted above, the amount of interest you can earn tax free is determined by which band you fall into. If you’re a basic-rate taxpayer your personal savings allowance is £1,000, but this halves to £500 for 40% taxpayers, while if your income exceeds £125,140 all savings interest is taxable.

An interesting quirk is that for those on particularly low incomes, your savings allowance could be as high as £6,000 due to a £5,000 starting rate plus you still get the £1,000 basic amount. These are in addition to your £12,570 personal allowance, meaning that if you had no other income you could potentially pocket £18,570 in savings interest, tax free.

Getting a firm grasp of the allowance available to you is important as it can inform the level of savings you can hold outside tax wrappers without facing an HMRC bill on the interest. For instance, as the top savings accounts currently pay around 5%, a basic-rate taxpayer with a £1,000 can hold around £20,000 before facing tax, while for a 40% taxpayer this drops to £10,000.

Where can the savings allowance be used?

Notably, it can’t be used within a stocks and shares ISA to offset any tax paid on uninvested cash from 6 April 2027. It can, however, be used on any interest accrued within a GIA.

How does the personal savings allowance work in Scotland given the income tax bands are different to other parts of the UK?

For Scottish taxpayers, the wider UK income tax system applies when determining an individual’s personal savings allowance. This means that, as the 40% rate in Scotland kicks in at £43,663 in 2026-27 compared to £50,270 for England and Northern Ireland, you could be a higher-rate taxpayer north of the border and still receive the first £1,000 in savings interest, tax free.

2) Review your ISA strategy

Despite the upcoming cuts to cash ISAs, they remain one of the most effective ways to protect interest from HMRC – especially for additional rate taxpayers who don’t enjoy a savings allowance.

This message isn’t lost on savers who have been pumping money into that version of the tax wrapper. Balances on adult cash ISAs soared £38 billion between January and May, presumably some under 65s maxing out the £20,000 figure before it drops.

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The reforms to uninvested cash within the stocks and shares type offer further food for thought. Unlike the cash ISA cut, the rules here apply to people of all ages; everyone will face 22% tax on uninvested cash. A further consideration is that under 65s will no longer be able to transfer holdings from a stocks and shares ISA to a cash ISA.

While the vast majority use a stocks and shares ISA to invest for the long term, there are natural reasons to need security with some holdings, so it’s vital to bear this charge in mind. One way to sidestep the tax is to use money market funds – a cash-like investment – as these will be eligible within the stocks and shares version from April 2027 provided the allocation doesn’t comprise 100% of your investments. As far as loopholes go, it’s a pretty simple one to exploit. Just make sure you invest a portion, even a few hundred quid, in shares or even gilts.

3) Appreciate the impact of taxable interest on tax traps and cliff edges

In certain scenarios, savings interest can face particularly punitive tax rates. That’s because it forms part of your total taxable income, relevant for those seeking to swerve the punishing tax traps and cliff edges.

These include the High-Income Child Benefit Charge, which affects parents of young children when one person’s income exceeds £60,000, and the gradual withdrawal of the £12,570 personal allowance once earnings surpass £100,000.

If your taxable interest lands in one of these snares after 6 April 2027, you could face an effective rate of 62% or perhaps even higher.

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For some parents, the drawbacks of savings interest surpassing a certain threshold could be even greater. If you have children aged between nine months and four years, and one parent earns just a pound above £100,000, the household could lose valuable free childcare, potentially making you tens of thousands of pounds worse off.

So, if you aim to keep your net adjusted income below one or more of these traps, perhaps by harnessing pension contributions as they act as a tax reducer, be sure to include any taxable interest in the calculation. It might require you to add a bit more to your pension to avoid a nasty sting.

4) Team up if married or in civil partnership

Being in a couple, whether married or in civil partnership, brings additional tax-planning opportunities. Your ISA and personal savings allowances double up, and you can put twice as much (£100,000) into Premium Bonds if you’re happy to forgo a guaranteed return for potential tax-free prizes.

Once your tax-free allowances and exemptions have been exhausted, a further option is to hold savings in a lower taxpayer’s name, if possible.

If one spouse or civil partner is in a lower tax bracket, your combined savings can attract a smaller tax rate, perhaps 22% instead of 42% or 47%, and help to maximise a more generous personal savings allowance. And importantly, if you’ve tied the knot, transferring money between each other’s accounts is exempt from inheritance tax (IHT).