The starting rate for savings and car finance compensation

The starting rate for savings is a tax-free band of up to £5,000 for interest. It is for people whose other income is under £17,570, and it sits on top of the Personal Savings Allowance (GOV.UK). The interest in car finance compensation counts as savings income, so the starting rate can cover it. When it does, the tax your lender deducted wasn’t owed, and it can be reclaimed from HMRC.

How the starting rate works

The band starts at £5,000. It goes down by £1 for every £1 of other income you have above your Personal Allowance of £12,570. Once your other income reaches £17,570, the band is used up (HMRC Tax Confident).

“Other income” means your taxable income apart from savings interest and dividends. That includes:

• wages and self-employed profits
• the State Pension and private or workplace pensions
• taxable benefits such as Carer’s Allowance, contribution-based Employment and Support Allowance and Jobseeker’s Allowance
• rental profits

Some benefits are tax-free and don’t count, including Universal Credit, Pension Credit, Attendance Allowance and Personal Independence Payment (GOV.UK).

How much interest can be tax-free

Savings income is treated as the top slice of your income (HMRC SAIM1090). In practice, any unused Personal Allowance covers interest first, then the starting rate, then the Personal Savings Allowance. These figures are for a basic-rate taxpayer with a £1,000 Personal Savings Allowance.

Other income in the tax year	Starting rate band left	Tax-free interest in total
£10,000	£5,000	£8,570
£12,570	£5,000	£6,000
£14,000	£3,570	£4,570
£16,000	£1,570	£2,570
£17,570 or more	£0	£1,000

In the first row, £2,570 of unused Personal Allowance is added to the £5,000 band and the £1,000 allowance.

An example with car finance compensation

Margaret has a workplace pension and State Pension totalling £15,000 in the 2027/28 tax year. She receives car finance compensation that includes £1,240.60 of interest, and the lender deducts 22%, which is £272.93.

Her other income is £2,430 above the Personal Allowance, so her starting rate band is £5,000 minus £2,430, which is £2,570. Add her £1,000 Personal Savings Allowance and £3,570 of interest is tax-free. The £1,240.60 of compensation interest is well within that, so none of the £272.93 was owed. She can get all of it back, provided she has no other savings interest using up the allowances.

What changes in April 2027

From 6 April 2027 the tax rates on savings income rise to 22%, 42% and 47%, and lenders will deduct 22% from interest instead of 20% (GOV.UK technical note). The starting rate and the Personal Savings Allowance don’t change. The government has fixed the £5,000 limit until April 2031 (GOV.UK).

So for anyone whose compensation interest is covered by the starting rate, the rate rise means slightly more to reclaim, because the lender takes 22% rather than 20%.

Who benefits most

The starting rate matters most for people with modest incomes, for example:

• retired people living on the State Pension and a small private pension (see our guide for pensioners)
• people working part-time
• people whose income fell in the year they were paid, through redundancy, illness or a career break

Your band depends on your income in the tax year you were paid, not the year you took out the finance. Our guide to which tax year compensation counts in explains why that matters.

Getting the tax back

If the starting rate or your Personal Savings Allowance covers the interest, the tax deducted is reclaimed with form R40, one claim per tax year. You can also claim from HMRC yourself. If you claim with us, we work out your band from your income, apply both allowances and submit the claim as your agent. Use the rebate calculator for a quick estimate.