I’m taking £12,570 from my pension. What tax do I pay on my £1,000 savings interest?

In our weekly series, readers can email any questions about their finances to be answered by our expert, Rosie Hooper. Rosie is a chartered financial planner at Quilter Cheviot and has worked in financial services for 25 years. If you have a question for her, email us at money@inews.co.uk. Question: I’m taking £12,570 a year from my pension – exactly the amount that can be earned tax-free before I start owing a 20 per cent income tax. But I also earn over £1,000 a year in savings interest, what rate will it be taxed at? Answer: This is a question that has come up while helping a client this week, and it’s likely to become more common. For the last few years, many people are finally seeing their savings interest go above the personal savings allowance. Shorts That’s undoubtedly good news, but it can create an unexpected tax headache if those higher interest payments push you over one of the savings tax thresholds. If you’re taking pension income that uses up your full personal allowance of £12,570 and you’re earning more than £1,000 a year in savings interest, don’t assume every pound above £1,000 will automatically be taxed. That’s because there is another tax break that often flies under the radar, which is the starting rate for savings. This allows up to £5,000 of savings interest to be received tax-free. However, it reduces by £1 for every £1 that your non-savings income exceeds yourpPersonal allowance. So, if your pension income is £13,000, that’s £430 above the personal allowance. In that case, your £5,000 starting-rate band would be reduced to £4,570. In this example, you’d still be a basic-rate taxpayer, you’d also qualify for the £1,000 personal savings allowance. In practise, that means you could potentially receive up to £5,570 of savings interest before paying any tax at all. One important point is that the picture often changes once the state pension gets paid to you. Following this week’s earnings figures, the full new state pension is on course to exceed £13,000 a year from April 2027 under the triple lock policy, although the final increase will not be confirmed until later this year. That would take it above today’s personal allowance of £12,570. For many retirees, adding even a relatively modest private pension on top could quickly erode, or completely remove, their entitlement to the starting rate for savings. In other words, someone who enjoyed generous tax-free savings allowances before reaching state pension age could find the rules look very different a few years later, despite their circumstances not feeling dramatically different. It’s worth noting that the Government has previously said that pensioners whose only income is the state pension will not face the administrative burden of paying tax simply because the state pension rises above the personal allowance. However, for those with additional income from private pensions or other sources, the interaction with the savings rules becomes much more important. The good news is that many people won’t need to complete a self assessment tax return simply because they have taxable savings interest. Banks and building societies report interest payments directly to HMRC and, in many cases, any tax due is collected automatically through PAYE by adjusting a tax code. However, this depends on your circumstances. If you already complete a tax return, have more complicated income arrangements, receive larger amounts of untaxed income, or HMRC cannot easily collect the tax through your tax code, you may need to report it separately. This is where a bit of forward planning can make a real difference. Someone who has done the sensible thing and built up a healthy cash savings pot may be delighted to see interest rolling in, only to discover that the success of their savings has created a tax bill they weren’t expecting. Making full use of ISAs can help avoid that problem altogether, as interest earned within an ISA remains free from income tax. For savers who are building up larger cash balances, it is also worth keeping an eye on potential future ISA reforms, as changes to the rules could alter how much money can be held in cash while retaining the full tax advantages. The key takeaway is that earning more than £1,000 of interest doesn’t automatically mean a tax bill is on the way. But as savings rates remain relatively attractive, tax thresholds remain frozen and state pension payments continue to rise, more people are likely to find themselves brushing up against these rules. Understanding how the starting rate for savings, the personal savings allowance and your other income work together can help you avoid surprises and keep more of your hard-earned interest in your own pocket.