A million more Britons will start paying tax on their savings this year as a result of a stealth raid by the Treasury and higher interest rates, analysis for the Telegraph shows.
Ten straight Bank of England rate rises from 0.1pc to 4pc have boosted earnings on thousands of savings accounts after years of dismal returns.
However, a £1,000 tax-free allowance on savings interest that was designed to spare most people from the taxman has not been increased in line with inflation since it was introduced in 2016.
Consultancy LCP said HMRC data suggested frozen thresholds alone had dragged an extra 125,000 people into paying tax on their savings as a result of inflation.
When interest rate rises are factored in, the number of people expected to pay tax on their savings is set to rise from 1.4m when the policy was introduced to roughly 2.4m in 2023, according Steve Webb, a partner at LCP and former pension minister.
Mr Webb said the savings allowance was no longer fit for purpose.
“When the Personal Savings Allowance was first introduced in 2016, it meant that the vast majority of people would pay no tax on their savings,” he told the Telegraph.
“But the world of 2023 is very different. We no longer have rock-bottom interest rates and inflation has eroded the value of the savings allowance. As a result we could be talking about an extra million people now paying tax on their savings.
“If the intention of the original policy was to take ordinary savers out of tax on their savings, the rate of the savings allowance needs a serious rethink as it is no longer achieving its original purpose.”
The calculations apply to taxable savings income only, with other accounts like Premium Bonds and ISAs offering a tax-free way to save. However, the £20,000 ISA allowance has also been frozen since 2017, which has also left more people exposed to demands from the taxman.
Under HMRC rules, basic rate taxpayers can earn up to £1,000 in interest without being charged income tax, while higher rate taxpayers have an allowance of £500.
LCP said a failure to increase the allowance in line with inflation meant basic rate taxpayers have missed out on roughly £236 of tax-free savings income. Higher rate taxpayers have lost out on £618.
Taxable savings interest income is 2.6 times bigger than it was in 2016, LCP said, which based its calculations on the returns of savers investing in an NS&I income bonds, which offer easy access and monthly interest.
In 2016, when the tax free allowance was introduced, a basic rate taxpayer would have needed £100,000 in NS&I income bonds at an interest rate of 1pc to pay any savings tax. In 2023, just £38,461 in NS&I income bonds at an interest rate of 2.6pc would trigger a demand from HMRC.
Chancellor Jeremy Hunt is under growing pressure to announce tax cuts at the upcoming March budget, though he has repeatedly ruled out giveaways.
Mr Hunt has also already frozen income tax thresholds until 2028.
The Office for Budget Responsibility, the government’s tax and spending watchdog, estimates the Chancellor’s move will generate an extra £26bn in revenues each year by 2028 and drag around six million people into higher tax bands.
High street banks and building societies have been much slower to pass on the Bank of England rate rises to savers than they have to borrowers with variable rate mortgages.
The average instant access account still pays just 0.83pc, while the average return in a fixed-rate bond is 1.67pc, according to Bank data.
There are already some exceptions on income tax for savings interest for people out of work or pensioners receiving other annual income of less than £17,570, who can earn up to £5,000 of interest on their savings and not pay additional tax.
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