ISAs versus top-rate saving accounts

admin
4 April 2013

Q

I'm always told ISAs should be my first port of call when it comes to saving but I've found a savings account paying a better rate than a cash ISA. Is it still better to opt for the tax-free savings vehicle?

A

You're right in saying ISAs are held up as the holy grail of savings ahead of actual savings accounts - and that is because of the tax benefits ISAs offer.

Each year, the amount of money you are allowed to save in ISAs - your allowance - increases. For the 2013/14 tax year, this will be £11,520, of which £5,760 can go into a cash ISA.

How important this tax-free saving vehicle is to you depends on what kind of taxpayer you are and what kind of interest rate an ISA pays, compared with a traditional savings account.

So, while an ISA will always beat a savings account in terms of the amount of tax you pay, a savings account that pays a better rate of interest can more than make up for the tax loss and will still pay you more.

Find the best Cash ISA or savings account for you

For example, if you are a non taxpayer – that is, your income is under the personal allowance – then you will not pay tax on any savings, so a 3% ISA is as good as a 3% savings account.

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If, however, you are a basic-rate taxpayer paying 20%, a savings account would need to be paying more than 3.75% to beat a 3% ISA - and the difference grows the higher rate tax you pay.

A brief glance at rates for the ISAs and savings accounts shows that savings are generally not running at good enough rates to make up for any money lost to the taxman - and so, tax-free ISAs are often the most efficient way to save.