Chancellor George Osborne said the Government will compensate any British Government and military personnel whose bank accounts in Cyprus may be affected by the European Union (EU) bailout levy.
European officials said people with less than 100,000 euro (£87,000) in their accounts will have to pay a one-time tax of 6.75% while those with more money will lose 9.9%.
Servicemen and women affected will be compensated by the government
Speaking on The Andrew Marr Show on Sunday morning, Osborne said: "For people serving in our military, for people serving our Government out in Cyprus - because we have military bases there - we are going to compensate anyone who is affected by this bank tax, people who are doing their duty for our country in Cyprus will be protected from this Cypriot bank tax."
The assurance comes after speculation on Saturday that about 3,500 British military personnel in Cyprus would face having their savings snatched.
Osborne credited Prime Minister David Cameron for ensuring Britain is not part of the bailout and alluded to statements posted on the websites of Bank of Cyprus UK and Laiki Bank UK assuring UK customers that their deposits would not be affected by the levy.
He said: "First of all, that is an example, in Cyprus, if you don't show the world that you can pay your way.
"That is why in Britain we've got to retain the confidence of world markets.
"What I'd say specifically about the Cyprus situation - first of all, we are not part of the bailout because David Cameron got us out of these Euro bailouts when he became Prime Minister.
"Second, I'd say that the Cypriot banks in Britain - this is important because there are many thousands of people who bank with Cypriot banks in Britain - those banks are not going to be included in this bank tax."
Osborne also called on people who despair at the UK economy to look at what is going on in Cyprus and realise that economic difficulties are widespread.
"Anyone who thinks Britain is alone in having these challenges should look on their TV screens, look at tonight's news, realise that it's a very tough economic situation out there," he said.
On Saturday, Kevan Jones, Labour's shadow armed forces minister, called on ministers in the UK to reveal whether they had fought to exempt British forces personnel in Cyprus to be made exempt from the levy.
"There are thousands of UK service personnel and their families based in Cyprus who could be impacted by this. Some may have served in Afghanistan," he said.
"Ministers must tell us how many personnel and their families could have their savings docked and whether they argued for exemptions for our forces. If not, the country will be angry and will want to know why not.
"Service families have been hit by cuts to allowances and permanent reductions in pensions by the Government.
"If our forces' savings are raided while they are stationed in Cyprus as part of their military service, the whole country will be outraged.
"Our heroes should not lose out while serving their country."
There are 59,000 British residents in Cyprus and 1.1 million Britons visit the island every year, the Foreign Office said.
Osborne: "It's a very tough economic situation out there"
An anonymous British serviceman contacted Sky News on Saturday to say: "Service personnel have no way of reaching their money and all electronic transfers have been barred by the Cyprus banks.
"Service personnel and their families are furious but can do nothing."
News of the levy came as a shock following strict assurances from president Nicos Anastasiades that he would not accept a deal which required depositors to share in the losses.
Lines formed at many ATMs in Cyprus on Saturday as people scrambled to pull their money following news of the raid on their savings - an unprecedented step in the eurozone crisis.
Christos Demetriades, 58, who was outside a shut Nicosia co-operative bank branch, said: "Politicians and senior bank bosses have covered each other's backs for years, now it's ordinary people who are paying the price and are being punished."
One disgruntled customer at a branch in the southern coastal town of Limassol briefly parked his tractor in front of its shut doors in a show of frustration.
But their attempts to avoid or lessen their tax burden by withdrawing cash appeared to be in vain.
Cypriot bank officials said that depositors can access all their money except the amount set by the levy, and officials added that withdrawing funds yesterday would not reduce anyone's levy.
Bank of Cyprus UK assured customers in the UK that their deposits would not be affected by the levy, as it is a UK bank and is protected by UK financial regulation.
Bank of Cyprus UK said on its website on Saturday: "Whilst the measures agreed include an up-front one-off stability levy on deposits in Cyprus, there is no effect on deposits with Bank of Cyprus UK Limited which is a UK bank.
"Bank of Cyprus UK Limited is a separately capitalised UK incorporated bank, is subject to UK financial regulation and eligible depositors are protected by the UK's Financial Services Compensation Scheme."
Laiki Bank UK said on its website: "Your eligible deposits with Laiki Bank UK are protected up to a total of 100,000 euro (£87.000) by the Cyprus Deposit Protection Scheme and are not protected by the UK Financial Services Compensation Scheme.
"Any deposits you hold above the 100,000 euro limit are not covered."
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