This 4% savings account is best for a DECADE – beware HMRC tax trap

As the Bank of England hikes interest rates, smaller “challenger” banks are offering some eye-catching savings deals. Atom Bank responded by launching a two-year fixed rate bond that pays a market-leading four percent, the first time any bank has offered that in a decade.

Atom has also increased its easy access Instant Saver rate to 1.90 percent, and other banks are set to follow suit.

This is brilliant news for savers after a dozen years of near-zero returns, even though it is still well below the August inflation rate of 9.9 percent.

The BoE is expected to increase base rates again in November and December, and this could push savings rates towards five percent.

This should bring more good news for savers but they should tread carefully, or they could find themselves paying income tax on their interest to HM Revenue & Customs again. This is something they haven’t had to worry about for years.

Even savers with relatively modest balances may now exceed a forgotten tax break called the Personal Savings Allowance (PSA).

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The PSA was launched by Chancellor George Osborne in April 2016. It allows basic rate 20 percent taxpayers to earn £1,000 a year from a non-Isa savings account, before paying income tax on the interest.

Higher rate 40 percent taxpayers can earn £500 a year tax-free under the PSA, although additional rate 45 percent taxpayers do not benefit.

When best buy savings rates paid just one percent a year, a basic-rate taxpayer needed £100,000 in savings before breaching the PSA.

Now that savers can secure four percent, they would breach it with just £25,000 in Atom’s account.

If they earned interest on other savings, too, they would blast through it even sooner.

A higher rate 40 percent taxpayer would only need £12,500 with Atom to breach the PSA.

If savings rates hit five percent later this year, as they almost certainly will, a basic rate taxpayer with £20,000 could breach the PSA.

A higher rate taxpayer could breach it with just £10,000.

The danger is real as one in six savings accounts hold balances of £15,000 or more, according to research by Paragon Bank. Its savings director Derek Sprawling said savers no longer need significant pots to start paying income tax.

Another issue is that salaries are increasing as inflation picks up, while income tax thresholds have been frozen for five years by former Chancellor Rishi Sunak.

New Chancellor Kwasi Kwarteng did not reverse this tax raid on Friday, even though it will push more than a million workers into the 40 percent tax band. “Savers could see their PSA halve overnight if their income tips over £50,271,” Sprawling said.

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Savers who risk breaching their PSA should reconsider tax-free Cash ISAs again.

This are available under every adult’s annual £20,000 ISA allowance, where all returns are entirely free of tax.

Cash ISAs pay slightly less than standard savings accounts, said Andrew Hagger, banking expert at MoneyComms.

For example, Shawbrook Bank’s two-year fixed rate cash Isa pays 2.80 percent, while the equivalent two-year savings fix from Close Brothers offers 3.71 percent.

“However, if your savings are set to push you over the PSA, it may be worth switching some of them into a Cash Isa,” Hagger said.

Whichever you choose, always shop around for the best deal, as rates are expected to rise higher as the banks respond to the latest base rate hike.

HMRC’s tax take will also increase.

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