Your complete guide to cash Isas
Even if your Isa provider were to go bust, deposits of up to £85,000 per person per institution are automatically protected by something called the Financial Services Compensation Scheme - meaning you'll get your money back if the worst were to happen.
Moreover, seeing as the maximum amount that could have been invested in a cash Isa since they were launched in 1999 stands at £71,040 – and only around one in six savers makes use of their annual allowance – that means they are very safe indeed.
They're also tax-efficient. To explain how, we need to get you up to speed on the basics. So here's the Moneywise guide to cash Isas.
How do they work?
Cash Isas are just like an ordinary savings account you'd get from your bank or building society. They come with a headline interest rate so, as long as you meet the conditions of the account, your money will grow at the rate stated.
The key difference, though, is that the interest that builds within a cash Isa is able to grow tax-free. An Isa is effectively a 'wrapper' around your savings, shielding your money from the taxman. Think of it like clingfilm around a sandwich, stopping any crumbs from falling off and landing in the taxman's lap.
If you are a basic-rate taxpayer, the wrapper protects the interest earned on your savings being deducted at a rate of 20%. For higher- and additional-rate taxpayers that rises to 40% and 45% respectively.
For this reason, a cash Isa beats a normal savings account paying the same rate of interest. 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 £30 of interest but you'd pay £6 in tax, leaving you with £24.
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 this can seriously mount 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.
Do I have to lock my money up?
Not necessarily. Depending on the type of account you choose, it's possible to get your hands on your cash whenever you need. But this easy access comes at a price – the account will either come with a low interest rate to start with, or you'll be penalised with a loss of interest after you make a withdrawal.
If you don't need easy access to your money, however, there are a range of fixed-term cash Isas you can lock your money in for a period of years that pay better interest rates.
How much can I put in a cash Isa?
Every tax year you are entitled to a new Isa allowance.
For the 2014/15 tax year (ending on 5 April 2015), this is £15,000, less anything deposited in a stocks and shares Isa. From 6 April, the allowance rises to £15,240.
Do I have to pay a fee?
Cash Isas tend to have no charges - just like savings accounts - though you may face penalties if you withdraw cash from an Isa where you have agreed to tie up your money.
Can I transfer my cash Isa to a better paying one?
Yes, and you may very well need to because rates tend to drop at the end of each tax year - unless you've locked your money away in a fixed-term account. Easy-access Isa providers, meanwhile, are able to cut their rates as they see fit. That means there's nothing to stop them attracting new customers with a decent rate of interest, only to slash it at a later date within the same tax year.
The difficulty savers then find themselves with is that, as they are only allowed to open one cash Isa and one stocks and shares Isa in any tax year, they are not then able to transfer money into a new cash Isa.
For example, if a saver opens a cash Isa with, say, NatWest, which then cuts the rate a few months later, the saver would not be allowed to open another cash Isa with another provider and transfer the money from the NatWest Isa. However, you can move money into previous years' Isas, though it is unlikely an older account will pay a better rate.
It's more often the case that savers open a new cash Isa in a new tax year, paying a better rate of interest than their previously opened Isas and decide to transfer money from the old accounts into the new - which is allowed.
But you should never withdraw the money and move it manually into the new Isa because you will lose your previous years' allowances. Instead, open a new Isa that allows 'transfers in' and inform the provider you wish to transfer funds from your existing accounts. It will take care of the process for you, resulting in the closure of the old accounts.
It's also possible to transfer your cash Isa to a stocks and shares Isa if you decide this is a better home for the money, and vice versa.
Who can have a cash Isa?
Any UK resident can open a cash Isa from the age of 16 (but you have to be 18 to open a stocks and shares Isa).
Where can I get one?
You can walk straight into a bank or building society branch and open a cash Isa, or open one over the phone or online if the provider allows.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
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.
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.