The death of the cash ISA?
The interest rate is likely to be cut again when the Bank of England meets next week, and with a new tax year on the horizon, concerns are rife that saving in cash is quickly losing its appeal.
Cash ISAs, which are 10 years old this year, are typically the first port of call for any saver because of their tax benefits. But with headline rates dropping dramatically in-line with the sharp falls in the Bank of England base rate, these tax-free accounts look like they might have lost their sheen.
At the start of 2008, it was possible for savers to earn up to 6% on a market-leading cash ISA, according to data provider Moneyfacts. Now, however, cash ISA savers would be lucky to achieve half that, with many ISAs paying less than 1%.
According to research by Moneyfacts, some of the worst cuts in ISA rates of late have been by banks, rather than building societies. Rachel Thrussell, head of savings at Moneyfacts, says: “One year ago, £5,000 worth of savings could have paid around £20 a month. Now these savers would be lucky to make £2.”
The dramatic fall in interest rates has severely punished the most prudent savers. “The Bank of England’s cuts mean that savers who have built up a healthy balance of about £30,000 by utilising their maximum cash ISA allowance each year since ISAs were launched could have seen their interest plummet by more than £1,200 a year,” says Andrew Hagger, a spokesperson from Moneynet.co.uk.
Despite job insecurity prompting many people to start or to boost their saving, the concern now is that falling interest rates – combined with stretched budgets and the rising cost of living – could put people off saving.
Figures from the Bank of England show that at the beginning of January 2008 the average rate on a cash ISA was 5.06%. However, 12 months later, the average rate was just 1.38% – the lowest since records began in 1999. As a result, savers appear to be withdrawing their money and seeking alternative homes for their savings.
Savers withdrew £2.3 billion from their nest-eggs in January, the first monthly fall in retail deposits since July last year and the largest amount since records began more than a decade ago, according to the British Bankers’ Association (BBA).
And the Building Societies Association reports that desperate income-seekers withdrew a collective £212 million from building society ISA accounts in December last year.
What's the alternative?
The diminishing returns offered by cash ISAs have also prompted more people to look at alternatives. New ISA rules introduced last April mean savers can now transfer their cash ISAs from previous tax years into stocks and shares ISAs.
Hargreaves Lansdown has seen an increase between November and January in the number of customers transferring their cash ISA balances into stocks and shares ISAs.
According to Mick Gilligan, head of research at stockbroker Killik & Co, the miserly returns offered by cash deposit accounts have made corporate bond funds look very attractive. “They are traditionally seen as a halfway house between savings and shares – riskier than savings accounts but less risky than the stockmarket,” he said. “The typical yield on the safest bond fund is currently 5%, but they can be as high as 17% for the riskiest bonds issued by companies relatively likely to go bust.”
However, transfers are one-way only – once an ISA is transferred out of cash and into stocks and shares, it cannot be switched back at a later date.
Jason Witcombe, a director at independent financial adviser Evolve Financial Planning, warns that people thinking of transferring their savings from cash into a stocks and shares ISA need to be comfortable with the risks involved, as their capital is not protected from falls in the stockmarket.
“You need to be prepared to invest for the long term and ride out the highs and lows of equity investing,” he said. “If you are concerned about the risk to your cash, it could be worth drip-feeding the account rather than investing a lump sum.”
Witcombe also recommends keeping a cash buffer before looking at longer-term investment. “How much this should be depends on your expenditure patterns, so you need to look at what would happen in the event of unemployment, or a large and unexpected bill, and work out how much cash you feel comfortable holding.”
For savers unhappy with the risk of investing in equities, the big questions on their lips is how long can interest rates remain so low and when they will start to see a decent return on their nest eggs.
Unfortunately, Stuart Porteous, head of RBS Group Economics, believes it won’t be this year. “Putting a floor under the fragile economy remains priority number one,” he said. “The UK’s eight million savers will have to play second fiddle for now.”
If you are in this position, Peter Vicary-Smith, chief executive of Which?, believes you should make sure your cash balance is working as hard as it can: “The big-name high street banks have consistently let their customers down, so savers should vote with their feet and move their money into one of the smaller institutions offering a decent rate.”
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.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.