HMRC warning: Almost 500,000 Britons face £1,080 tax blow after savings shake-up - check if you're affected

Savers who continues to save £20,000 annually will see the additional £8,000 become taxable once their interest exceeds their Personal Savings Allowance.

Over five years, that could cost a basic-rate taxpayer about £288 and a higher-rate taxpayer £1,080 in tax as interest earned outside the ISA wrapper becomes liable, according to calculations by investment platform InvestEngine.

Their research, which draws on HMRC figures show7.1 million people paid into a Cash ISA in 2022/23, and more than a quarter saved above the new £12,000 limit.

Of those, almost 1.5 million were basic-rate taxpayers and 462,000 were higher-rate taxpayers - roughly 15 per cent of the UK’s 13.3 million Cash ISA holders.

Andrew Prosser, Head of Investments at InvestEngine, said: "Our analysis shows that almost 1.5 million basic-rate taxpayers and just under half a million (462,000) higher-rate taxpayers deposited more than £12,000 into their Cash ISA in the last financial year; now that the allowance has been cut down to £12,000 they will need to find somewhere else for this cash for anything over that amount."

The detailed calculations reveal how quickly tax liabilities accumulate for those saving the £8,000 difference in standard savings accounts earning 4.5 per cent interest.

Basic-rate taxpayers remain within their £1,000 Personal Savings Allowance for the initial two years, avoiding any tax liability.

However, from year three onwards, they begin paying tax on £80 of interest, resulting in a £16 bill.

This escalates to £88 in year four as £440 of interest becomes taxable, before reaching £160 in year five when £800 exceeds the allowance.

Higher-rate taxpayers experience immediate impact due to their reduced £500 allowance.

They avoid tax only in year one, then face an £88 bill in year two when £220 of interest becomes taxable. The burden increases to £232 in year three, £416 in year four, and peaks at £600 in year five.

The Personal Savings Allowance stands at £1,000 for basic-rate taxpayers and £500 for those paying the higher rate, with additional-rate taxpayers receiving no allowance at all.

With current savings rates hovering around 4.5 per cent, these thresholds are rapidly exceeded when funds previously sheltered in Cash ISAs move to standard accounts.

Mr Prosser explained: "If they were to put that £8,000 - the difference between £20,000 and the new £12,000 limit - into a 4.5 per cent savings account, after five years, a basic-rate taxpayer will have lost around £288 in tax, while a higher-rate taxpayer could lose around £1,080, or £216 a year once their total savings interest exceeds the £500 allowance."

The reduction forces savers to choose between accepting tax liabilities on interest or exploring alternative investment vehicles such as Stocks and Shares ISAs.

However, if instead, a basic-rate taxpayer ISA saver was to invest that same £8,000 into a Stocks and Shares ISA instead of a taxable savings account, they could be almost £2,200 better off after five years, while a higher-rate saver would be nearly £3,800 better off over the same period.

Mr Prosser concludes: "Our analysis shows that millions of savers regularly deposit more than £12,000 a year into Cash ISAs. This cut to the allowance could push many into paying unnecessary tax on their savings interest.

"However, while the cut is undoubtedly a blow for those who were planning to save more than £12,000 into a Cash ISA, now is a good opportunity for those who have not invested before to consider it as a way of reaching their financial goals.

"By shifting part of their allowance - anything over £12,000 - into a Stocks & Shares ISA, savers can preserve the tax benefits of the full £20,000 limit while giving their money a chance to benefit from inflation-beating growth."