Millions of UK households could be missing out on a significant tax break that allows them to earn a combined £18,570 from work and savings completely free of income tax. Personal finance experts, including ITV's Martin Lewis, have highlighted a little-known rule that can substantially boost the amount of money lower earners can keep from the taxman.
Understanding Your Core Tax-Free Allowances
Every individual in the UK receives a Personal Allowance, which is the amount of earned income you can receive each year without paying tax. For the current tax year, this standard figure is £12,570. On top of this, most savers benefit from a Personal Savings Allowance (PSA). This permits basic-rate taxpayers to earn £1,000 in savings interest tax-free, while higher-rate taxpayers can earn £500.
As Martin Lewis explained, this means a basic-rate taxpayer would need around £21,000 in a top easy-access account (at 4.75%) to generate £1,000 in interest and use their full PSA. For higher-rate taxpayers, the figure is approximately £10,500 to earn £500.
The Powerful 'Starting Savings Rate' for Lower Earners
The key to reaching the £18,570 tax-free threshold lies in a provision called the starting savings rate. This is specifically designed for individuals on lower incomes who have substantial savings, a situation common among many pensioners.
Here is how it works in practice:
- If your earned income uses up your entire £12,570 Personal Allowance, the starting savings rate can grant you an extra £5,000 in tax-free savings interest.
- You then add your standard £1,000 Personal Savings Allowance on top of that.
- This creates a total potential tax-free allowance of £12,570 (earnings) + £5,000 + £1,000 = £18,570.
However, there is a crucial taper. For every pound of earned income you receive above your Personal Allowance, you lose £1 of the £5,000 starting savings rate allowance. Therefore, if you earn £13,570 (£1,000 above the allowance), your starting savings rate drops to £4,000. Once your earned income reaches £17,570, the starting savings rate is reduced to zero, though you would retain your standard £1,000 PSA if you remain a basic-rate taxpayer.
Where Cash ISAs Fit Into Your Tax-Free Strategy
Martin Lewis also clarified the role of Cash ISAs in this landscape. Interest earned within a Cash ISA is entirely separate from these allowances and does not count towards them. This means you could theoretically have the full £18,570 from earnings and taxable savings interest tax-free, and then earn additional interest in a Cash ISA on top, with all of it remaining untaxed.
This makes ISAs a powerful tool for those who may exceed their allowances in the future or simply want an extra layer of tax protection. For savers with amounts below the thresholds needed to generate £1,000 in interest, however, using a standard savings account may be just as effective without tying up funds in an ISA.
The guidance underscores the importance for individuals, particularly pensioners and others on modest incomes, to review their combined income from work and savings to ensure they are not overpaying tax and are utilising every allowance available to them.
