Over-65s are paying more Income Tax on savings interest. Here’s what you should know:

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A freedom of information (FOI) request from Paragon suggests that over-65s are forecast to pay 21.5% more Income Tax on their savings interest between 2022/23 and 2025/26.

Let’s break down what this means for retirees and why this increase has been so stark.

Your savings interest could trigger a tax charge

When you save cash into an easy access, notice or fixed term account, you may not realise that you could be required to pay tax on the interest payments you receive.

This has to do with your Personal Savings Allowance (PSA). Each tax-year, which runs from 6 April to 5 April of the following year, your PSA resets. It marks the amount of interest your savings can generate without triggering an Income Tax charge.

Your PSA depends on your Income Tax bracket, which are detailed below:

_{*Your Personal Allowance is tapered down by £1 for every £2 you earn over £100,000. Once you enter the additional-rate tax bracket, your Personal Allowance disappears completely.}

The more you earn, the less PSA you benefit from:

To provide some examples:

• You earn £45,000 a year, so you can earn up to £1,000 in savings interest before paying Income Tax on it.

• You get a new job and your salary goes up to £60,000 a year, meaning only the interest above £500 will be taxed.

• Your partner earns £150,000 a year. They don’t have a PSA, so all their savings interest will be subject to additional-rate Income Tax.

At the end of the tax-year, your bank or building society will send a report to HMRC detailing how much interest each account holder has accrued. So, you could be contacted by HMRC if you owe Income Tax on your savings interest.

Frozen Income Tax bands and higher interest rates create the “perfect storm” for retirees

You could be wondering: “If the PSA is based on earnings, why are retirees set to pay so much more tax than usual on their savings interest?”

1. The above Income Tax bands are frozen until 2028. While wages rise and retirees accumulate more wealth, a greater portion of the UK’s earnings is likely to be pulled into a higher Income Tax bracket.

2. Since the COVID-19 pandemic, interest rates have risen. While this is good news – your savings can generate more – it also means more people are exceeding the PSA.

When you retire, your income will likely come from a few key sources, some of which are subject to Income Tax.

Let’s imagine you retired in December 2025 at age 68. You are entitled to the full new State Pension, which stands at £230.25 a week (£11,973 a year). Almost your entire Personal Allowance will be taken up by State Pension payments.

You take your tax-free cash (25% of your personal pension pot), equalling £100,000, and place £70,000 of it in a cash account earning 4% interest. You spend the rest in the first year of your retirement, topped up by your State Pension.

The result: you’re a basic-rate taxpayer with a PSA of £1,000. In a year’s time, your £70,000 has gained £2,800 in interest – leaving £1,800 vulnerable to Income Tax. So, some of your tax-free cash ends up being whittled away by Income Tax.

It’s now clear why, as Paragon has reported, retirees’ Income Tax on savings interest has shot up. Higher-for-longer interest rates, combined with frozen Income Tax bands, are leaving retirees exposed.

Planning ahead can help prevent avoidable taxation of your savings

If you are on the approach to retirement, understanding how Income Tax will be applied to your income, if at all, means you can avoid the over-taxation of your savings.

It helps to establish the following before you retire:

• How much you plan to draw from your pensions each year
• The amount in State Pension payments you are entitled to
• The interest your cash savings are likely to generate
• Whether any of your other income will be taxed, such as rental property income.

From there, you can explore solutions that may mitigate the tax you pay. Referring to the example above, you could consider a flexi-access strategy instead of taking your entire tax-free lump sum at once. This avoids placing a large amount into a cash account that may end up being taxed.

That said, it is always worth taking independent financial advice before making big decisions about your retirement.

Get in touch with Kellands Hale for bespoke financial advice

Kellands is an award-winning financial planning firm based in Hale, Cheshire. Our team, made up of sector-leading experts, is here to help you form a retirement plan that suits your goals, ensuring your financial position is aligned with what you want to achieve in your later years.

Email us at hale@kelland.co.uk, or call 0161 929 8838.