Most people arrive at retirement with more cash than they have ever held and less earned income than at any point since they were twenty. That combination changes how interest is taxed, usually in your favour, and hardly anyone is told the rules. Here is how they work for 2026/27, with the figures done properly rather than assumed.
Three allowances, in a fixed order
Interest is income, and it is taxed after your other income, in three layers.
- Any personal allowance you have not used. The allowance is £12,570. If your pensions come to less than that, the gap can be filled with interest at 0%.
- The starting rate for savings. Up to £5,000 of interest at 0%, but it is reduced by a pound for every pound your other income exceeds £12,570, so it has gone completely once other income reaches £17,570.
- The personal savings allowance. £1,000 of interest at 0% for a basic-rate taxpayer, £500 at higher rate and nothing at additional rate. This one does not depend on how much of it you have used elsewhere.
Everything above the three layers is taxed at your marginal rate, 20% for most retirees.
The cliff between £12,570 and £17,570
Put those together and the amount of interest you can earn tax-free depends sharply on your pension income. All of these people are basic-rate taxpayers:
| Pension and other income | Interest you can earn tax-free |
|---|---|
| £12,000 | £6,570 |
| £16,000 | £2,570 |
| £20,000 | £1,000 |
| £30,000 | £1,000 |
| £55,000 (higher rate) | £500 |
That is the whole story in one column. Someone on £12,000 of pension can hold a very large sum in ordinary savings accounts and pay nothing. Someone on £20,000 gets the £1,000 and not a penny more. The difference is not income tax on the pension; it is the starting rate for savings quietly disappearing between the two.
What a real pot pays
Take £40,000 in an easy-access account at 4.5%, which is £1,800 of interest a year:
| Pension and other income | Tax on £1,800 of interest |
|---|---|
| £12,000 | £0 |
| £16,000 | £0 |
| £20,000 | £160 |
| £55,000 | £520 |
Now make it £100,000 at 4.25%, so £4,250 of interest. On £16,000 of pension the tax is £336; on £20,000 it is £650; at higher rate it is £1,500. Same cash, same rate, and the bill more than doubles across a £4,000 difference in pension.
The starting rate for savings is worth up to £5,000 of tax-free interest, and it vanishes a pound at a time between £12,570 and £17,570 of other income.
What counts as other income, and what does not
The state pension counts, in full. Private and workplace pensions count. Rental income counts. Dividends are added after interest, so they do not squeeze the starting rate. Then the things that do not count, which is where the planning is:
- The 25% tax-free part of any pension lump sum is not income and does not appear anywhere in this calculation.
- Interest inside a cash ISA is not income. If you are above the cliff, moving savings into an ISA at £20,000 a year is the simplest way back under it. Where to park cash covers the options.
- Premium Bond prizes are tax-free and do not count.
- A small pot lump sum is 25% tax-free and 75% income, so taking one in the same year can push you over the cliff on its own.
Scottish taxpayers are taxed on savings interest at the UK rates and bands above, not the Scottish ones, even though their pension income uses the Scottish bands.
How the tax is collected
Banks have paid interest without deducting tax since 2016, so nothing is taken at source. They report what they paid you to HMRC, which usually collects any tax due by adjusting the tax code on your pension the following year. Above £10,000 of interest you are expected to fill in a tax return. If a code adjustment appears and you do not recognise it, this is almost always what it is.
The savings interest tax calculator works all three layers for your own pension income and balance, and tells you how much more interest you could earn before any tax is due.
If you are approaching retirement rather than in it, the AI Wealth Assistant will tell you whether a cash ISA or a pension top-up does more for you this year.