ISA, offset mortgage & more ways to beat the savings tax trap

Healthier savings rates mean far more of us are paying tax on our savings pots, but there are some smart ways to avoid doing so.

One overlooked beneficiary of more generous interest rates is the tax man. 

Most of us benefit from the Personal Savings Allowance, which allows us to earn a certain amount in interest each financial year, without paying any tax on it.

For Basic Rate taxpayers that allowance is worth £1,000, dropping to £500 for Higher Rate taxpayers and nothing for Additional Rate taxpayers.

With savings rates having risen substantially over the last two years, it means far more of us will now be earning enough to exceed their allowance, meaning more cash making its way to HM Revenue & Customs (HMRC).

Clearly, no saver actually wants to miss out on some of those returns, so it may be worth considering some of these tactics which will allow you to beat the savings tax trap.

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Make use of your ISA

The first port of call for many of us will likely be looking a bit harder at where our money is saved, and particularly focusing on ISAs.

The selling point of ISAs has always been that the returns are completely tax-free, but in recent years, the allure of ISAs has dropped off a bit. 

With interest rates so low, most savers were not earning enough to exceed their annual personal savings allowance.

As a result, savers could prioritise putting their money in accounts with the highest rates on offer, irrespective of whether they were an ISA or not.

That situation has changed somewhat with rates rising so quickly, and so many savers are now potentially at risk of paying tax on their returns.

It means that focusing your saving within an ISA wrapper is much more important, as no matter what tax band you fall into, you can ensure that you keep every penny of the interest generated.

It’s also worth highlighting that the sheer range of ISAs available now means that it’s important to work out which is going to be the right option for your saving goals.

If you’re trying to get a deposit together or supplement your pension saving, then a Lifetime ISA will be the right pick but in other cases, you may be better off with a different form of ISA.

Check out our guide to ISAs for more.

Work together

You may be able to sidestep the taxman by working together with your partner on your savings. 

For example, while your own savings pot may be enough to breach the Personal Savings Allowance threshold, your partner may have little in savings to their name and so their allowance is going unused.

Transferring some of your savings into an account in their name could mean you reduce your tax liability.

It’s a similar story with ISAs.

We all get a £20,000 annual ISA allowance, but teaming up with your partner means you can put away £40,000 each year without handing anything over to HMRC. 

Given there’s a new tax year starting in eight months, that’s effectively £80,000 that you could save between you in ISAs over the next year, and enjoy completely tax-free returns in the process.

There are some clear downsides to this approach of course, namely what will happen to that cash should you break up, plus the question of control if one of you is less good at resisting the temptation to dip into the savings on a regular occasion.

What about Premium Bonds?

Another alternative option, if you are feeling particularly lucky, is Premium Bonds. 

The winnings from bonds are tax-free, which is just one of the selling points for them.

What’s more, the prize rate is currently at its highest level since 1999.

That means more prizes on offer, and an improved chance of winning.

If you are determined to keep the taxman’s mitts off your cash and have already maxed out your ISA allowance, then sticking some leftover savings cash into Premium Bonds isn’t the worst idea.

Just be warned, if your luck isn’t in you could quite easily never land a prize at all, so there is an element of gambling involved. 

Tap into an offset mortgage

One way to ensure you don’t have to pay tax on your savings is to abandon looking to get a return from your pot completely.

No, seriously, it might actually be a smart money move.

Offset mortgages are a really nifty way that you can use your savings pot to reduce the amount of interest charged on your mortgage debt.

Basically, with an offset mortgage, your savings are offset against the size of the loan to work out how much interest you really have to pay.

Let’s say you have a £200,000 outstanding mortgage. With a regular deal, you’ll have to pay interest ‒ likely at around 5% at current rates ‒ on the entirety of that debt.

But with an offset mortgage that sum is reduced by the size of your savings pot. 

So if you have £40,000 in savings, that means you only pay debt on the remaining £160,000 of your mortgage debt. 

That could allow you to significantly drop the size of your monthly repayments, while you could keep your repayments at the same level and simply clear the mortgage debt faster, saving thousands on interest payments in the process.

With an offset mortgage you are sacrificing the potential to earn interest on your savings pot, so that’s important to bear in mind.

However, given you aren’t going to be earning 6% plus on a savings pot of any real size then financially it may make sense to pay that price in order to make tackling your mortgage easier.