Are Your Savings Going Down The Drain?
- Shaun Crozier
- Jul 10
- 3 min read
Updated: Jul 18
Are your savings actually growing?
Saving money is smart, but keeping more of it is even smarter. While savings accounts are a popular choice for risk-free growth, many savers underestimate how much tax can eat into their returns. Once you exceed your Personal Savings Allowance, the taxman takes a slice of your interest. Add inflation to the mix, and your real return could be far less than expected, sometimes sub zero!
Understanding how these factors interact is crucial to preserving the long-term value of your savings. With a few smart adjustments, you can make sure your money is working harder for you.
What Is the Personal Savings Allowance (PSA)?
Your PSA is how much interest you can earn tax-free each year. It was introduced to help everyday savers earn some interest without facing immediate tax penalties, especially during periods of low interest rates. The allowance you receive depends on your income tax band:
Basic rate taxpayers (20%): £1,000 allowance
Higher rate taxpayers (40%): £500 allowance
Additional rate taxpayers (45%): No allowance
Any interest beyond that is taxed at your usual income rate, and most banks won’t deduct it automatically. You will need to register for self-assessment/submit a return if your interest is more than your allowance.
How Tax and Inflation Shrink Your Returns
Imagine you put £50,000 into a savings account paying 4.5% interest. That gives you £2,250 per year.
As a basic rate taxpayer, you’d pay 20% tax on anything above your £1,000 allowance. That’s £250 in tax, reducing your return to £2,000.
But inflation makes things worse. At 3% inflation, the value of your £50,000 drops by £1,500. So, after tax and inflation, your real gain is just £500, even though the rate looked generous.
So, if you’re a 40% or 45% taxpayer in real terms its far worse. Our examples below for each tax band clearly demonstrates the impact.
How to Save Tax on Savings Interest
While tax on savings interest is hard to avoid entirely, there are ways to reduce your exposure. With a bit of planning, you can structure your savings to minimise the amount lost to HMRC and make the most of available allowances.
Use an ISA: Interest earned in an Individual Savings Account (ISA) is completely tax-free and doesn’t count towards your PSA.
Split savings with a spouse or partner: If one partner has a lower income, shifting savings can help you maximise combined allowance.
Track your earnings: If you're approaching or exceeding the PSA, consider spreading funds across accounts or using tools to track your interest.
Look at premium bonds or tax-free bonds: These offer alternative ways to earn returns without affecting your PSA.
Final Thoughts
Even the best interest rates can disappoint when tax and inflation are factored in. By understanding your Personal Savings Allowance and using tax-efficient options like ISAs, you can protect your savings growth and make sure more of your money stays yours.
Small changes in how you save can make a big difference in how much you keep.
Other related articles you may find interesting:
