Are cash Isas still better than savings accounts in 2017?
With some current accounts paying as much as 5% interest and everyone now having access to a personal tax-free savings allowance, there might seem little need for the humble cash individual savings account (Isa). But in a rapidly changing market, we shouldn’t understate the security offered by the nation’s favourite tax-free account.
By the end of the 2015/16 tax year, more than £269 billion was being held in cash Isas with the average saver holding £6,338. However, savers will be well aware that the rates on Isa accounts have been dropping for some time. Data provided by Moneyfacts shows the average easy access Isa rate fell from 2.56% in January 2012 to 0.82% at the start of 2017.
Some current accounts now offer much higher rates, and this has tempted many people to save by splitting their money between several current accounts.
Plus the introduction of a personal tax-free savings allowance of £1,000 in April 2016 means the tax-free advantages of cash Isas don’t seem so essential. These rules mean basic-rate taxpayers can earn up to £1,000 in savings income tax-free, from any source, while higher-rate taxpayers are able to earn £500 in any given tax year.
Is there any point in sheltering your cash savings in an Isa wrapper if you're unlikely to have to pay tax on them anyway?
If you saved the maximum £15,240 into a cash Isa this year and got the average 0.82% on your savings, you would only earn £124.97 interest for the year. To get £1,000 annual interest on a 0.82% rate, you would need to have £121,951 saved up.
But keeping your cash inside an Isa wrapper still has benefits. For a start, the personal savings allowance is new government policy and future governments could review it or take it away. Second, if you make the maximum savings into a cash Isa each year, then you might breach the personal savings allowance sooner than you think.
A person who had maxed out the Isa limit each year since its introduction in 1999 would have at least £121,520 in cash, plus all the interest paid on top of that, by the end of the 2017/18 tax year.
What is more, if interest rates go up in future, the Isa wrapper gives you protection. At 2% interest, you would only need £50,000 in cash Isas to reach the personal savings allowance of £1,000. Also, if your yearly earnings are more than £150,000, then you do not receive a personal savings allowance, meaning all your non-Isa savings are taxed at 45%.
It is also worth remembering that most current accounts only pay interest up to a certain amount – often just a few thousand pounds. In the upcoming tax year, savers will be able to put £20,000 in their Isa – up from the £15,240 allowance in 2016/17. This is in addition to any previous Isa contributions.
How to choose the right cash Isa
There are several types of cash Isa account, both fixed and variable rate, ranging from easy access to long-term accounts. All major banks and building societies offer a range of Isas that anyone aged 16 or over can open. So what is the best strategy for getting a return on your cash?
Which cash Isa account you choose will depend on how quickly you want to access your money. Easy-access accounts allow you to withdraw funds at any time without paying a penalty – these are the best choice for people who need flexibility.
Easy-access accounts tend to have lower rates than other cash Isas and can often include an introductory bonus which expires after a year, so make a note of this in your diary and switch accounts when this happens. Some of these accounts also have restrictions on the number of withdrawals that you can make in any tax year.
Notice accounts are slightly less flexible versions of easy-access Isas. Here, you can withdraw your cash at any time but you’ll need to give a notice period, which can range from 30 to 90 days.
It should also be noted that some Isas pay more interest on higher balances or require a minimum deposit for you to open an account.
Fixed-term accounts pay more interest, but your money is locked away and can’t be accessed without paying a large penalty. These fixes range from one to five years – and the longer you’re willing to stash cash, the higher the rate you’ll receive. For those willing to fix for five years, the best cash Isa rate is from Paragon at 1.6%; this compares to 1% from the easy-access best buy Isa from NS&I.
Remember that if interest rates rise during your fixed period, you won’t see your rate increase – but you will be protected if rates drop further.
Switch to make your money work harder
While you can only open one cash Isa each tax year, you are able to switch your existing Isa pot between providers.
This means that if rates fall you can move to a new bank or building society – as long as they allow transfers in. Cash Isas rarely come with a fee, although it is worth checking what withdrawal penalties are associated with your account – especially if you’re closing your account in order to switch elsewhere.
It is also important to ask your new provider for an Isa transfer form – don’t simply withdraw or transfer the cash yourself as you’ll lose all the tax-free benefits associated with the account.
Top tip: Remember that in the event of a bank failure, the Financial Services Compensation Scheme will only guarantee the first £85,000 of savings with each financial institution. So if you do have a sum of this size, make sure it is split between two or more providers that don’t belong within the same banking group.
Moneywise cash Isa picks
|Type of account||Provider||Interest rate||Comments||Available|
|Easy access||NS&I Direct Isa||1%||No transfers allowed||Online and phone|
|Notice account||Family Building Society 35 Day Notice Cash Isa||1.05%||Only for balances over £30,000||Branch, online and post|
|One-year fix||Leeds Building Society||1.01%||Branch, online and post|
|Fixed Rate Isa Issue 91||-|
|Three-year fix||Virgin Money e-Isa Issue 217||1.25%||Online only|
|Five-year fix||Paragon Bank Fixed Rate Isa||1.60%||Only balances between £500 and £100,000.||Online only|
All accounts are covered by the Financial Services Compensation Scheme
How average Isa rates have fallen over five years
|Average Isa rates||Jan-12||Jan-13||Jan-14||Jan-15||Jan-16||Jan-17|
Source: Moneyfacts, 19 January 2017
A savings account on which the account holder is required to give a period of notice before making a withdrawal or face a penalty, usually a loss of a specific number of days’ interest or pay a fee. Notice periods of 30, 60 or 90 days are common. These accounts usually pay higher than average interest rates and require large initial deposits (£1,000 minimum) so the notice period and penalties are there to discourage withdrawals. Some of these accounts will only allow a certain number of withdrawals a year.
The ISA rules allow investors to transfer money from an uncompetitive savings account with one provider into one from another provider that pays a better rate of interest. The bank to which you are transferring the money must do the transfer process, as withdrawing the money from the ISA wrapper means you lose the tax-free status. You can transfer a cash ISA into a stocks and shares ISA, but not the other way around and the current tax year’s cash ISAs must be moved whole to a single provider, but previous years’ ISAs can be split between new providers.
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.