How cash ISAs can work for you
THIS ARTICLE IS NOW OUT OF DATE, DUE TO CHANGES TO THE ISA RULES IN APRIL 2008. FOR MORE RELEVANT ISA ARTICLES CLICK HERE.
Tax savings aside, cash ISAs are exactly like savings accounts. You deposit money into an account and the value of this is guaranteed not to go down. Instead, you receive interest on a regular basis so over time your money will grow. You can save up to £3,000 of your £7,000 annual allowance in a cash ISA. Withdrawals are permitted, with many offering instant access to your savings.
However, if you do invest your maximum allowance, once you've made a withdrawal you can't top up the account until the next year - a great incentive to leave your money invested and let it grow tax-free.
Unlike stocks and shares ISAs, where the minimum age is 18, you only need to be 16 to take advantage of this tax-efficient savings vehicle. This makes them an option for your children's savings too.
These characteristics have made cash ISAs increasingly popular since they were introduced in 1999. Back then, 4.6 million cash ISA accounts were opened, with total investments of some £11.6 billion. Today, these figures have grown significantly .
Why invest in a cash ISA
The tax-free nature of cash ISAs makes them an ideal home for your savings. For example, if you were to select a cash ISA paying 5.5%, a basic-rate taxpayer would need a savings account paying 6.875% to get the same amount of net interest. For a higher-rate taxpayer, they'd need an account with a gross interest rate of 9.17%.
Comparing gross rates, cash ISAs tend to pay slightly more than savings accounts. You should use your cash ISA allowance even if you don't intend to leave your savings there for years, especially as many are instant access.
The ISA rule changes from April 2008 will make this strategy even more sensible; you'll be able to transfer money held in cash ISAs into equity ISAs. This additional flexibility will make saving into a cash ISA even more attractive.
Pick the best one
There are plenty of cash ISAs available, with most of the banks and building societies offering at least one. Although there are so many on offer, picking the one that's right for you doesn't have to be difficult. Best-buy tables are available in Moneywise or you can check out websites such as Moneyfacts (www.moneyfacts.co.uk) or Interactive Investor (iii.co.uk) for the latest interest rates.
Like savings accounts, rates track the base rate, with the best ones above it. As well as looking for the ISA with the best rate, it's also important to consider how you want to run your account. ISAs can be managed over the internet, by telephone, post or through a branch, so make sure you pick one that suits you.
You'll also need to compare other product features such as bonuses, rate guarantees and notice periods to ensure they suit your savings requirements. Introductory bonuses are fairly common on cash ISAs, especially among those at the top of the best-buy tables. Typically, part of the rate on offer will be paid in the form of a bonus after a set introductory period.
There's nothing wrong with bonuses, especially if you can switch between ISAs paying them. However, if you forget to switch or there is a penalty for switching (for instance the Portman will charge you £30 to transfer to another provider) the advantage of the bonus soon disappears.
Notice periods and penalties
Another feature to look out for with cash ISAs is a notice period. Around 40% of cash ISAs include some form of notice period, ranging from seven days to five years. It is possible to access your money before the notice period, but you will incur a penalty. For shorter notice periods, up to 60 days, this penalty is usually loss of interest for a period equivalent to the notice, while, for products with longer notice periods, you could lose up to 150 days' interest.
Traditionally, the reward for tying up money in a notice account was a higher-rate of interest, but competition in the market means this is no longer a safe assumption. However, even if a notice account isn't the best deal they can still make sense for savers who want restrictions to prevent them raiding their account, or, in the case of fixed-rate products, the certainty that the rate is guaranteed and won't be reduced in a few months' time. Similarly, some ISA providers offer tiered rates or have relatively high minimum investments, giving bigger savers the benefit of a higher interest rate. For example, Alliance & Leicester's cash ISA pays 3.7% for balances of £1 but, if you've saved your full allowance each year and have £21,000 with the bank, it'll pay 4.8%.
Also check the small print. Some ISAs will have conditions on the number or size of withdrawals you can make. Others, especially the fixed-rate accounts, don't allow additional payments. And some of the regular savings options will reduce your interest if you miss a payment. If you don't want the hassle of checking all the terms and conditions you could go for a stakeholder ISA. This is guaranteed to meet certain standards on charges, access and interest rates set by the Government. They must have no charges and be able to accept a minimum deposit of £10, or less, by cash, cheque, standing order, direct debit or by BACS. Unlimited withdrawals must be permitted, with the cash available within seven days. Interest rates must be no less than 1% below the Bank of England base rate and, if this increases, the provider must pass on the increase within a month.
Transferring a cash ISA?
It's also worth keeping an eye on the rate your cash ISA pays. Although the providers tend to play a bit fairer than with savings accounts, rates can slide and you might be able to earn more interest by moving. This is certainly worth doing if you've gathered up a handful of ISAs over the years.
Switching between ISAs is straightforward. First check that you can move your money to the new provider and that there aren't any penalties for leaving your existing provider. Once you're happy that you won't get stung for transferring, contact the new provider. They will give you an ISA transfer form to complete, which will include details of your current provider. Once they have these details they'll contact the provider and request the transfer on your behalf.
It should take less than a month for your money to turn up in your new cash ISA and many providers will pay you interest from the day your money leaves your old ISA provider so you're not out of pocket.
You don't need to transfer your entire cash ISA either, unless it's money that counts towards this year's tax allowance. This has to be transferred in its entirety.
With previous years' ISA money you are free to divide it between providers. So, for example, if you paid £3,000 into an ISA two years ago you could transfer £1,500 into one ISA and the remaining balance into another. This will be particularly important when the new ISA rules that allow you to transfer money from a cash ISA to a stocks and shares one come into effect next year. Then, the added flexibility will allow one you to create the perfect portfolio to suit your needs.
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.
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.
Created in 1968, BACS is a not-for-profit industry body, owned by 16 of the leading banks and building societies in the UK and Europe. All direct debits, standing orders, credit card payments, personal loans and the vast majority of salary cheques are processed through BACS. In 2010, 5.7 billion UK payments with a total value of £4.06 trillion were processed through the system.
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.