Millions of households could legally earn up to £18,570 a year without paying any tax, thanks to a little-known rule from HM Revenue & Customs (HMRC). While most workers are familiar with the standard Personal Allowance, fewer realise that additional savings allowances can significantly increase the amount of income they can receive tax-free.
With income tax thresholds frozen until 2031, understanding how these rules work has become increasingly important for savers and low earners alike.
The Frozen Personal Allowance
The standard Personal Allowance — the amount you can earn before paying Income Tax — currently stands at £12,570. This threshold has been frozen since 2021 and is set to remain unchanged until 2031.
As wages gradually rise due to inflation, more people are being pulled into paying tax or pushed into higher tax bands. This process, known as “fiscal drag”, means households may face higher tax bills even if their real income hasn’t improved significantly.
However, for those with lower earnings and savings income, there is a way to legally expand their tax-free income beyond £12,570.
What Is the Starting Rate for Savings?
The key lies in HMRC’s “Starting Rate for Savings” — a rule that allows eligible individuals to earn up to £5,000 in savings interest tax-free on top of their Personal Allowance.
If you earn less than £12,570 from wages or a pension, you can potentially qualify for the full £5,000 starting rate band. This means savings interest within that band would be taxed at 0%.
In simple terms:
- £12,570 Personal Allowance (tax-free)
- Up to £5,000 Starting Rate for Savings (tax-free)
That already brings the potential total to £17,570.
Don’t Forget the Personal Savings Allowance
On top of the Starting Rate for Savings, most basic-rate taxpayers are also entitled to the Personal Savings Allowance. This allows an additional £1,000 of savings interest to be earned tax-free.
When all three allowances are combined, eligible individuals could receive:
- £12,570 (Personal Allowance)
- £5,000 (Starting Rate for Savings)
- £1,000 (Personal Savings Allowance)
This totals £18,570 of income that could potentially be tax-free.
Money saving expert Martin Lewis has explained that if someone earns less than £18,570 in combined employment and savings income, they may not have to pay tax on their savings interest at all.
How the Allowance Reduces
The Starting Rate for Savings is not available in full to everyone. It gradually reduces as your non-savings income increases above £12,570.
For every £1 you earn above the Personal Allowance, your £5,000 starting rate band shrinks by £1.
If your non-savings income reaches £17,570 or more, the Starting Rate for Savings disappears entirely.
For example:
- If you earn £16,000 in wages, £3,430 of that sits above the Personal Allowance (£16,000 minus £12,570).
- That £3,430 reduces your £5,000 Starting Rate for Savings to £1,570.
- Any savings interest within that £1,570 would still be taxed at 0%.
Even if the Starting Rate is reduced, you may still benefit from the £1,000 Personal Savings Allowance.
A Real-World Example
Consider someone with no earned income but £20,000 in savings interest.
Here’s how the allowances would apply:
- First £12,570 covered by Personal Allowance
- Next £5,000 covered by Starting Rate for Savings
- Next £1,000 covered by Personal Savings Allowance
That means £18,570 of the £20,000 would be tax-free. Only the remaining £1,430 would be taxable at the basic rate of 20%, resulting in a £286 tax bill.
Without understanding these combined allowances, someone in this position might wrongly assume they owe tax on the full £20,000.
Can You Reclaim Overpaid Tax?
If you have already paid tax on savings interest but believe you qualified for one of these allowances, you may be able to reclaim it.
Claims can typically be made through a Self Assessment tax return, and refunds can be backdated for up to four tax years. This could provide a useful cash boost for those who were unaware of the rules.
Why This Matters Now
With income tax thresholds frozen for a decade, more savers are finding themselves affected by rising interest rates and higher returns on savings accounts. As savings income increases, so does the risk of paying unexpected tax.
Understanding how the Personal Allowance, Starting Rate for Savings, and Personal Savings Allowance interact could help households keep more of their money.
While this isn’t technically a loophole, it is an underused rule that many people overlook. For low earners, pensioners, and those living partly off savings, checking eligibility could mean earning up to £18,570 a year without paying Income Tax.
