Savers who avoided cash ISAs to chase the best interest rates could now be left with unwanted tax bills that wipe out the extra interest they’ve earned, calculations by investment platform AJ Bell have shown.

Figures indicated that over the past five years savers using non-ISA accounts, which tend to pay slightly higher interest than ISAs, could see the benefits erased if they breach the personal savings allowance and must hand money to HMRC.

A recent freedom of information request from AJ Bell revealed that an estimated 2.75 million taxpayers are expected to pay tax on savings interest this year. Many opted not to use cash ISAs to shelter interest from the taxman when hitting the £1,000 personal savings allowance looked possible thanks to much lower rates of interest.

AJ Bell’s calculations showed that an individual who saved £10,000 a year for the past five years would have earned an extra £255 by chasing the best rates, opting for non-ISA accounts and switching regularly to get the best terms. However, now interest rates have risen and their savings have grown, they would now breach the personal savings allowance and face paying tax on their savings interest.

That same individual would pay £247 this year in tax on their savings if they’re a basic rate taxpayer – meaning this year’s tax bill almost entirely wipes out the benefit of saving outside ISAs over the past five years.

A higher-rate taxpayer who saved that same £10,000 a year over the past five years faces paying £694 in tax this year, while an additional rate taxpayer would be paying £1,006 in tax – almost four times more than the additional gain they saw from using a non-ISA account.

Head of personal finance at AJ Bell, Laura Suter, commented: “The number of people using an ISA dropped dramatically after the personal savings allowance launched in 2016, as it meant the majority of people wouldn’t pay tax on their savings. On top of that, savers chased the higher returns on offer from non-ISA accounts.

“That logic worked fine while interest rates were low, but now a combination of higher interest rates and more people being pushed into the next tax bracket thanks to frozen allowances means vastly more people are paying tax on their savings.”

Suter added: “The mantra until now has been that you only need to use an ISA if you’ll pay tax on your savings, but that’s not the case. You should consider both your current situation and your future one: you need to think about whether you are ever likely to pay tax on your savings.

“For those with smaller savings pots it’s less of an issue, partly because you’re less likely to breach your personal savings allowance and partly because you can move all your savings into an ISA in one tax year.

“But anyone building up wealth over time runs the risk of paying tax on their savings and not being able to quickly move it all into an ISA.”

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