HM Revenue and Customs (HMRC) is sending tax demand letters to individuals with as little as £3,500 in their savings accounts. This is because banks automatically report interest earned on savings to HMRC, and exceeding certain thresholds can trigger a tax bill. The Personal Savings Allowance allows individuals to earn a certain amount of interest tax-free each year. For those earning under £50,270, this allowance is £1,000 per year. For those earning between £50,271 and £125,140, it is £500 per year, and for those earning £125,140 or more, the allowance is £0.
The amount of tax owed depends on an individual's income, the total interest earned, and when it was paid. Fixed savings accounts, where interest is often paid out in a lump sum upon maturity, can lead to exceeding the allowance even with a relatively small principal amount. For example, £3,500 in a fixed savings account earning 5% interest over three years would result in more than £500 in interest paid out in a single tax year. If this person also earns over £50,270, they would exceed their £500 allowance and potentially receive a tax bill. Similarly, £11,000 in an easy-access account at 5% for one year would yield £550 in interest, exceeding the allowance for higher earners. For those earning less than £50,270, £21,000 in savings at 5% for one year would generate £1,050 in interest, exceeding the £1,000 allowance. Various other sources of income, including unit trusts, investment trusts, peer-to-peer lending, and bonds, also count towards this allowance. If an individual exceeds their allowance, they will pay tax on the interest above the threshold at their usual income tax rate. For those employed or receiving a pension, HMRC may adjust their tax code to collect the tax automatically, basing estimates on the previous year's earnings. Cash ISAs are an exception, as their interest is protected from tax, provided the deposit limit is not exceeded.