How to choose the best cash ISA for you
Whether you're saving a few pounds for a rainy day or you're putting aside more for your future, a cash ISA should be your first port of call.
Unlike ordinary savings accounts, the key benefit of a cash ISA is that any interest you receive is paid tax-free. This can make a significant difference to the value of your savings. Take an interest rate of 3% as an example. If you're a basic-rate taxpayer, you'll pay tax on your interest at 20%, so over the course of a year, £1,000 in a traditional savings account will generate £24 of interest. For a higher-rate taxpayer, paying tax on interest at 40%, the return will fall to £18. But hold your £1,000 in an ISA, and you'll receive the full £30.
Although this may only be a difference of a few pounds, over time it can quickly rack up. For instance, assuming interest rates remain at 3% and you don't add any more money to your account, in an ISA your £1,000 will have grown to £1,159 after five years. A basic-rate taxpayer using a taxed account would have £1,126, while a higher-rate taxpayer would have £1,093.
Because of the tax advantage, there are limits on the amount you can save into a cash ISA. The maximum for the 2013/14 tax year is £5,760 which can be paid in as a lump sum, a regular monthly payment of up to £480 or a series of ad hoc payments.
This maximum can reduce if you pay more into your stocks and shares ISA. The 2013/14 rules allow you to pay up to the full ISA allowance of £11,520 into a stocks and shares ISA, with anything over £5,760 eating into the amount you can pay into your cash ISA.
Although you can have a cash ISA that allows you to pay money in one day and withdraw it the next, if you do take money out you won't be able to replace that part of your ISA allowance in the same tax year.
Pick the best cash ISA
Just like traditional savings accounts, there are all sorts of different features and account types available. So to find the best cash ISA for you, it's important to think about what you want from your account.
For starters, you need to decide whether you want an instant-access account or you're happy to lock your money away for anything from 30 days to five years plus. With penalties in place on ISAs with notice periods or fixed terms, if you're likely to need access to your money quickly or before the end of the fixed term, it's best to plump for an instant-access ISA.
If you need to cash in a fixed rate you can expect to be penalised with a loss of interest on your savings, which could undo all the benefits of choosing that account in the first place. But given that these accounts do typically pay more than instant access they can be a great choice if you can afford to tie your money up for a while.
Keep on top of bonuses
Many of the top-paying accounts will also pay an introductory bonus rate. There is nothing wrong with choosing an account that pays a bonus but you do need to be mindful of when the rate expires so that you can move your money before the interest rate drops through the floor. Make a note in your diary or check out the Rate Tracker Service offered by savingschampion.co.uk. If you aren't prepared to keep moving your money, you'll be better off accepting a lower rate that lasts.
Regular savings cash ISAs are also available. These require you to commit to a monthly savings pattern, for which you'll receive a slightly higher interest rate than on an instant-access ISA.
This monthly commitment can work well for many savers who can pay a chunk of their salary in each month but, unfortunately, there are only a handful of products on the market. You'll usually lose interest if you miss a payment so make sure you commit to saving for a year before making your choice.
Whichever type of cash ISA you pick, you'll also need to make sure the account terms are right for you. Minimum investment levels can vary, with some starting at £1 while others, especially the fixed-term products, will have the minimum set at £500 or more.
Conditions can also apply if you're looking to move money from an existing cash ISA. Some, especially those with more chunky rates, tend to shun transfers-in to help them control the amount of money they attract. Because of this, make sure the ISA you choose will accept your existing ISA balance if you are looking to find a new home for it.
What if my bank goes bust?
Finally, when you're picking an ISA, think about what would happen if the provider went bust. Cash ISAs are covered by the Financial Services Compensation Scheme, which will pay compensation up to the limit of £85,000 per person for each authorised bank or building society that fails.
This one limit on compensation can apply to different firms within one group – for example, Birmingham Midshires, Halifax and Saga are part of the Bank of Scotland – so make sure you don't inadvertently exceed the £85,000 limit when selecting your cash ISA.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.