ISA, monthly interest & more ways to beat the savings tax trap

Millions of us are paying tax on our hard-earned savings, 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 accounts currently paying up to 4.91%, it means you won't need to have a huge sum set aside before some of your interest will start making its way to HMRC.
For example, a Basic Rate Saver with a top account could start paying tax from £20,400, while for Higher Rate savers it's just £10,200.
Clearly, no saver actually wants to miss out on some of their returns, so it may be worth considering some of these tactics which will allow you to beat the savings tax trap.
1. 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, so no matter what tax band you fall into you can ensure that you keep every penny of the interest generated.
We're also in a unique situation where the best Cash ISAs currently outperform the best traditional savings accounts: you can now earn up to 5.1% tax-free, compared to 4.91% on taxable accounts.
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.
2. 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 less than three 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.
3. 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.
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.
It's also worth noting the prize rate has fallen sharply in recent months and currently pays just 4%.
4. 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.
5. Long-term savings? Get interest paid monthly
The final trick will only be relevant to anyone looking to lock their money into a long-term fixed-rate savings account.
The proble with such accounts is the total sum of your interest is usually paid out as a lump sum at the point of maturity.
Imagine if you've locked into a five-year deal, that means you'll be getting five years' worth of interest paid out in one tax year, making it highly likely you'll exceed your Personal Allowance.
One possible way around this is to get your interest paid out monthly if that's an option.
While you won't benefit from the wonders of compounding your interest, you will at least get it paid out across five separate years, making it less likely you'll rack up a tax bill.
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