A risk-free way to grow your nest egg

Last updated: Aug 23rd, 2011
Feature by Sam Barrett

Cash individual saving accounts are the simplest form of ISA, operating in exactly the same way as a savings account, but with the added bonus of paying you interest tax-free.

This means that cash ISAs have very broad appeal. Unless you intend to use your full ISA allowance of £7,200 for your stocks and shares ISA, their tax-free status means they should be your first choice for your savings.

For this tax year, you can invest up to £3,600 in a cash ISA (and if you're over 50, you can put away up to £5,100), providing you don't exceed this amount with your stocks and shares ISA. If you do exceed this, however, you're limited to the balance of the full ISA allowance of £7,200.

Although the fact that you can't top your ISA up again if you make any withdrawals makes it particularly suitable for long-term savings, a cash ISA should also be your first choice for your emergency savings.

For example, if you're a basic-rate taxpayer with £3,000 in a cash ISA paying 2.65% this would give you £79.50 in interest over a year.

If you went for a 'normal' instant access savings account paying 2.76% gross, you'd receive £66.24 in annual interest after tax is deducted.

They are even worth considering if you don't pay tax. Although you'll get exactly the same return from a tax perspective, anything you save into a cash ISA will be safeguarded if your tax status changes in the future.

Additionally, they can also appeal if you'd normally invest in stocks and shares ISAs but you're not very confident about the performance of the stockmarket.

As you can transfer cash ISAs into stocks and shares ISAs, you can save into your cash ISA now and make the move when you feel more upbeat about the market's outlook.

However, although they're a fairly straight-forward product, it's important to understand the different features.

Checking interest rates

Interest rates will probably be the first feature you scrutinise, but even here it's not a straightforward case of which product has the highest rate. Bonuses are a common feature with cash ISAs, helping providers to inch up the best-buy tables.

As well as bonuses, check whether you're being offered a fixed or a variable-rate cash ISA. With everything pointing towards interest rates rising in the next couple of years, it might not be worth going for a long-term fixed rate as rates might get better in the future.

With most of these products, you'll need to commit for at least a year to get a fixed rate, with the best rates (for now) available over the longer term.

However, all come with catches if you jump ship early. Making a withdrawal might result in you losing a certain number of days' interest or having your account closed altogether. 

Rewards and commitments

If you don't want to commit for the long term, then you may be able to get a higher rate if you're prepared to give notice on any withdrawals.

Some providers insist on a different type of commitment with their regular savings ISAs. Just like standard savings accounts, a handful of providers have cash ISAs set up specifically to reward regular savers.

These require you to commit to making regular payments in exchange for extra interest.

You may also be able to boost your cash ISA rate by going for a deal where you take out another product with the same provider.

Other providers offer preferential rates to existing customers.

To be sure you're not caught out by headline rates that change later, check the best-buy tables on a regular basis.

You can do this on Moneywise in our round-up of the best cash ISAs. When you do find your rate's slipped, it's easy to transfer and get more for your money.

If you don't fancy chasing rates then you might want to consider picking a cash ISA that has a consistently good rate. Moneyfacts surveys the market and puts together details of the most consistent rates over the previous 18 months.

These don't necessarily pay the best rates but offer consistent value for money, so there's no need to shop around all the time for a good rate.

Bag a better rate – how to transfer your cash ISA

If your cash ISA isn't up to scratch it's easy to transfer it to another provider. But you need to be aware of the rules because if you withdraw the money yourself, you'll lose the tax-free allowance altogether.

1. Open a new ISA with the new provider.

2. Complete a transfer request form – your new provider will give you one of these and will send the completed form to your current provider.

3. Under HM Revenue & Customs rules, your current provider has 30 days in which to transfer the money to your new provider.

4. As soon as your new provider receives the transfer you can start to earn interest on your new cash ISA.

You should also check you won't be hit with a penalty for transferring from your current provider. The majority don't impose a penalty and, even where they do, it's usually in the form of loss of interest for up to 120 days. You might find this worth forfeiting in return for a higher interest rate. 

As well as sticking to these rules, it's also important to understand what you can transfer. Although it's fine to transfer part of a previous tax year's cash ISA allowance, if you've opened a cash ISA in the current tax year you must transfer all of it to a new provider.

It's also worth noting that many of the most competitive rates on the market do not accept transfers.

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