Millions now face having to pay tax on their savings for the first time in seven years as interest rates soar: Here's what savers should do

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Savers will have to pay tax on their savings interest for the first time in nearly seven years.

Rising interest rates mean earnings from savings accounts could soar by hundreds of pounds this year.

This means millions of basic-rate taxpayers could bust their £1,000 personal savings allowance for the first time since its introduction in April 2016.

- Check out the best fixed rate savings deals here. 

Tax thresholds: Rising interest rates mean that earnings from savings accounts could soar by hundreds of pounds this year.

At the same time, income tax thresholds have been frozen until April 2028. So those who get a pay rise could be dragged up from the 20 per cent basic-rate tax bracket to the higher 40 per cent rate.

As a result, their personal savings allowance will halve to £500 and any interest they earn above this level will be liable for tax.

Tax changes in this month's budget are also expected to take some 232,000 taxpayers into the 45 per cent additional rate tax bracket. They will receive no concessions at all on their savings interest.

Basic-rate tax starts when your income hits £12,571. You'll pay the higher 40 per cent rate once your income reaches £50,271 and the additional 45 per cent rate will kick in at £125,140 from April 2023. This was reduced from £150,000 in the Budget earlier this month.

The personal savings allowance gives around 27.2 million basic-rate taxpayers the first £1,000 they earn each year from an ordinary savings account tax-free.

The 5.5 million higher- rate taxpayers have an allowance of £500, while the 629,000 additional rate payers don't get anything. Check how much interest you are likely to earn with our long-term savings calculator.

The allowance has not risen since it was introduced. Laura Suter, head of personal finance at investment platform AJ Bell, says: 'Income tax allowances have been frozen, so more people are being pushed into the next tax bracket and seeing their personal savings allowance cut or disappear altogether.'

Part of the reason more people are at risk of paying tax is because the amount of money invested in taxable savings accounts has soared since then — by per cent 47 per cent to £1.167 trillion.

Years of low interest rates have meant savers didn't have much chance of using their tax-free allowance. But with better rates and increased savings, that is set to change.

Sarah Coles, a personal finance analyst at investment platform Hargreaves Lansdown, says: 'Now that interest rates are higher, if you put more cash on deposit, there's an ever- increasing chance that you'll breach the allowance.'

Last year, the best easy-access account paid around 0.5 per cent. As a basic-rate taxpayer, you could have £200,000 in your account and not earn enough interest to breach the personal savings allowance. For higher-rate payers, the sum was £100,000.

Now, with the best rate at 2.81 per cent, the sums have dropped to around a sixth of these levels, at £35,587 and £17,793 respectively.

Latest figures from HM Revenue and Customs show that in the year to April 2020, 13.9 million taxpayers received interest on their savings with banks and building societies.

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What should savers do?

Look to use your Isa tax-free allowance. Once the darling of the savings world, cash Isas fell out of favour thanks to persistent low interest rates and the arrival of the personal savings allowance.

Isas work in the same way as an ordinary account, but all your interest is automatically tax free, you can check the best deals in our best cash Isa savings tables.

Nor does it count towards your income when working out the level of income tax you have to pay.

You can save £20,000 each tax year — which runs from April 6 one year to April 5 the next.

Top rates include 2.5 per cent from Scottish BS and Cynergy Bank on easy-access accounts.

If you pay tax, this is a better rate than earning a slightly higher 2.81 per cent in a non-Isa account.

After basic rate tax at 20 per cent, that works out at 2.24 per cent or 1.68 per cent for a higher-rate payer.

The top one-year fixed-rate Isa is 3.78 per cent from Shawbrook Bank, while the best bond is 4.35 per cent from Atom or GB Bank.

The latter will be worth 3.4 8 per cent after tax to a basic-rate payer and 2.6 1 per cent to someone who pays higher-rate tax.