Recent changes to the way that interest is taxed and the introduction of the Personal Savings Allowance (PSA), which came into force in April, could result in savers unexpectedly facing a ridiculous amount of tax to pay on some of their income.

Interest earned on banks and building society accounts is no longer paid net of tax, but instead a PSA will apply, which allows basic rate taxpayers to earn £1,000 in interest tax- free and higher rate taxpayers £500, while additional rate taxpayers do not have any allowance.

It is an all or nothing amount that can be received tax-free. This means that if, as a basic rate tax payer, you earned £1 over the threshold to the extent that you become a higher rate tax payer on that £1, you lose the £1,000 allowance and instead the £500 PSA applies. This can result in very unfavourable tax scenarios where people can effectively end up subject to taxes of a multiple, rather than a percentage of what they earn.

Let’s take the example of an individual with total income just below the higher rate tax threshold after accounting for the 1.25% interest generated on their £80,000 of savings.

The interest totals £1,000, which is up to the limit of the PSA and as such, is tax-free. But if they add £800 to the account, resulting in an extra £10 of interest being generated, this additional interest (regardless of how small it is) pushes them into the higher rate tax bracket meaning £4 of the extra £10 interest is due in tax.

Now, as they are a higher rate tax payer on a portion of their income, their Personal Savings Allowance drops to £500. The result is that basic rate tax at 20% is now due on £500 of their interest, which amounts to £100. So that extra £10 of interest gave rise to a £104 of tax falling due – an effective tax rate of 1,040%!

The impact of the rules mean that it will be significantly more beneficial to take moderate earnings that push an individual into the next tax bracket and give it to charity or contribute it to a pension to avoid losing the PSA. In the example above, giving £10 to charity would result in more than ten times that amount staying in your wallet instead of going to the taxman’s coffers.

For a borderline basic rate taxpayer, with £1,000 or more of interest from deposit accounts, receiving anything less than £166 beyond the basic rate tax threshold will mean that more than all of that excess will be due to the taxman.

Of course, having a bedrock of deposit-based savings is shrewd financial planning, but because of this penal tax trap, it’s worth considering where the relevant tax thresholds correspond to your total income and whether an alternative home for some of the money could significantly improve your tax position.

Sheltering interest bearing holdings in tax shelters, such as ISAs where interest is tax-free could be even more beneficial than previously assumed, as could moving savings from the higher rate to the lower rate taxpayer of a couple or, even to alternative investment vehicles subject to more favourable Capital Gains Tax treatment.

An interest rate rise may be what you’re waiting for to boost the meagre amount that is now earned on deposits, but to ensure that this money ends up in your wallet, rather than the taxman’s, the careful assessment involved in sound financial planning is necessary.