When your savings actually start being taxed
Cash is the one part of a portfolio where the tax treatment is genuinely complicated, and where most people either worry about a bill they will never get or fail to notice one they will. Three separate allowances stack up before any tax is due on interest, in this order.
- Your personal allowance. The first £12,570 of total income is untaxed, and interest counts as income for this, so someone with little other income can receive a great deal of interest tax free.
- The starting rate for savings. Up to a further £5,000 of interest is taxed at 0%, but the band shrinks as other income rises and has gone entirely by £17,570 of other income.
- The personal savings allowance. Then £1,000 of interest is tax free for a basic-rate taxpayer, £500 for a higher-rate taxpayer, and nothing at all for an additional-rate taxpayer.
The practical consequence is that the allowance runs out sooner than people expect. At a 4.5% rate, purely as an illustration, £1,000 of interest is a balance of about £22,000, so a higher-rate taxpayer with a decent emergency fund and a savings pot can be paying tax on cash while assuming they are not. The savings interest tax calculator works out your own position, and a cash ISA is the usual answer once you are over the line.
How much cash, and where
Cash has one job in a plan, which is to stop you selling investments or reaching for a credit card when something breaks. That argues for a firebreak first, then a fuller emergency fund, and no more than that: money held in cash beyond what the job requires is money quietly losing to inflation. Where to actually keep it, and why the firebreak comes before the debt.