Do Banks Deduct Tax on Interest

At Towerstone, we provide accountancy services in Bedford to local sole traders, landlords, and limited companies. We have written an article about Do Banks Deduct Tax on Interest to help you understand how bank interest is taxed, and what happens before and after personal allowances.

This is a question I am asked regularly usually when someone notices interest hitting their bank account and wonders whether HMRC has already taken its share. From experience there is a lot of outdated information still floating around because the rules did change a few years ago and not everyone realised.

In this article I am going to explain clearly whether banks deduct tax on interest in the UK how the system works now who still needs to pay tax on savings interest and when you might need to take action yourself. This is based on current UK rules and what I see in practice when reviewing tax returns and savings income for clients.

By the end you should know exactly where you stand and whether you need to worry about declaring anything to HMRC.

The short answer

No. UK banks no longer deduct tax from savings interest.

Interest is now paid gross which means before tax. If you owe tax on that interest it is your responsibility to pay it usually through HMRC rather than the bank.

This applies to most UK savings accounts including current accounts savings accounts and fixed rate bonds.

Why people still think banks deduct tax

From experience this confusion comes from how things used to work.

Before April 2016 banks deducted basic rate tax from savings interest before paying it to you. Many people still assume that system is in place especially if they remember seeing tax deducted on older statements.

That system no longer exists. Since April 2016 interest has been paid gross and the tax treatment is handled separately through HMRC.

If you have not actively looked into this since then it is easy to assume nothing changed.

What paying interest gross actually means

When interest is paid gross the bank credits the full amount of interest to your account.

No tax is deducted at source. The bank does not know your tax position and does not attempt to apply tax rates.

From experience this often surprises people because the interest arrives looking clean and final. In some cases it is. In others tax is still due later.

The key point is this. The bank paying interest gross does not mean the interest is tax free.

The Personal Savings Allowance

The reason many people do not pay tax on savings interest is the Personal Savings Allowance.

This allowance means you can earn a certain amount of interest each tax year without paying tax on it depending on your income tax band.

For most people this allowance covers all of their savings interest which is why no further action is needed.

How much interest you can earn tax free

The allowance depends on your tax status.

Basic rate taxpayers can usually earn up to £1,000 of savings interest tax free each tax year.

Higher rate taxpayers can usually earn up to £500 tax free.

Additional rate taxpayers do not get a Personal Savings Allowance.

From experience many people do not realise they have this allowance or how generous it can be especially when interest rates rise.

When you do not need to do anything at all

If your total savings interest for the tax year is within your Personal Savings Allowance you do not need to pay any tax on it.

In most cases you also do not need to tell HMRC.

HMRC receives information directly from banks and building societies. If no tax is due nothing further happens.

From experience this applies to the majority of people with modest savings balances.

When tax is still due on interest

Tax becomes due when your total savings interest exceeds your Personal Savings Allowance.

At that point the excess is taxable at your marginal rate.

For example if you are a basic rate taxpayer earning £1,200 in interest £1,000 may be tax free and £200 taxable.

Because the bank has not deducted tax you will owe tax to HMRC instead.

How HMRC collects tax on savings interest

In many cases HMRC collects the tax automatically by adjusting your tax code.

This often happens for employees and pensioners who are already within the PAYE system.

HMRC uses information reported by banks to estimate your interest and adjusts your tax code so that additional tax is collected gradually.

From experience people often notice their tax code change and do not realise it is linked to savings interest.

When you need to complete a Self Assessment return

If you already complete a Self Assessment tax return you must include your savings interest even if it is below the allowance.

The tax calculation will then apply the allowance automatically.

If you do not normally complete a tax return you only need to start one because of savings interest if the interest is significant or HMRC asks you to.

From experience this usually applies to people with larger savings balances or those already within Self Assessment for other reasons.

Interest from different types of accounts

Most UK savings interest is treated in the same way but there are important exceptions.

Interest from ISAs is tax free regardless of amount. You do not pay tax on ISA interest and it does not count towards your Personal Savings Allowance.

Interest from offshore accounts may still be taxable in the UK depending on your residency status and must usually be declared.

From experience ISAs remain one of the simplest ways to earn interest without worrying about tax.

Joint accounts and interest

For joint accounts interest is usually split equally between account holders for tax purposes unless there is clear evidence to support a different split.

Each person applies their own Personal Savings Allowance to their share.

From experience this can be useful for couples where one partner has unused allowance.

What about fixed rate bonds and notice accounts

Fixed rate bonds and notice accounts are treated the same as other savings accounts.

Interest is paid gross and taxed if it exceeds your allowance.

The timing of when interest is paid matters. Tax is based on when the interest is credited or made available not when the account matures.

From experience this catches people out with longer term bonds where interest rolls up and is paid at the end.

Do banks tell HMRC about interest

Yes. Banks and building societies report interest paid to HMRC.

You do not need to send bank statements or interest certificates unless asked.

From experience HMRC usually already knows roughly how much interest you earned even if you are unaware of it.

This is why ignoring interest rarely works long term.

Common misunderstandings I see

The most common misunderstandings include:

Thinking interest is tax free because no tax was deducted
Assuming banks still deduct basic rate tax
Believing ISAs and normal savings accounts are taxed the same
Not realising interest counts towards taxable income

Each of these can lead to surprises when HMRC updates a tax code or issues a calculation.

Why this matters more now than before

As interest rates have increased savings interest has become more meaningful.

From experience people who never previously exceeded their allowance are now doing so simply because rates are higher.

This makes it more important to understand how the rules work rather than assuming interest is always tax free.

Practical steps to stay on top of it

My practical advice is simple.

Keep a rough record of interest earned across all accounts during the tax year.

Be aware of your Personal Savings Allowance based on your income level.

Check any tax code changes from HMRC rather than ignoring them.

Use ISAs where appropriate to shelter interest from tax.

The key takeaway

So do banks deduct tax on interest. No they do not.

Interest is paid gross and tax is handled separately through HMRC if it is due.

For many people the Personal Savings Allowance means no tax is payable at all. For others especially as savings grow or rates rise tax can quietly become due.

From experience the key is awareness. Once you understand that banks no longer deduct tax the rest of the system makes far more sense and you can plan your savings accordingly.

For further guidance across related topics, visit our Bedford Accounting Hub, which brings together practical advice for Bedford clients.