The popularity of Cash Isas has been falling in recent years as savers look for higher paying alternatives.
Many people are turning towards Stocks and Shares Isas, which potentially offer better returns.
Savers have also become less interested in Cash Isas since the introduction of the personal savings allowance in 2016. This allows basic rate taxpayers to receive £1,000 (£500 for higher rate taxpayers) of cash interest tax free each year.
Cash Isas have also fallen out of favour because of falling interest rates and the widening gap in rates with savings accounts.
As a result, many savers are putting their cash into savings accounts, which give them a higher return than Cash Isas.
For example, one of the highest-paying two-year bonds from Tandem Bank pays out 2.3%, well above the 1.87% for the current best buy Two-Year Fixed Rate Cash Isa from Charter Savings Bank.
However, once you exceed the £1,000 personal allowance you start paying tax, so a Cash Isa might be a better bet.
Anna Bowes from Savings Champion says that despite the drop in popularity, Cash Isas remain important for people who are looking to save tax free above the personal allowance limit.
She adds: “In many cases it makes sense for savers to go for the higher paying savings account because the personal allowance means they won’t have to pay tax on the first £1,000.
“If they are putting more money away they are likely to be better off with a Cash Isa because they are tax free.
“For those who want to keep funds in cash and have already used their personal savings allowance, it makes sense to lock some of it up in a tax-free savings account.”
You can save up to £20,000 tax free a year, which you can’t do with other savings accounts. If you plump for an easy access Isa you can also get to your money whenever you want without losing interest.
“A Stocks and Shares Isa may offer higher returns but the risks are greater”
Isa or fixed-rate bond?
Once you’ve gone above the £1,000 limit on the personal allowance the 20% tax rate on interest kicks in.
To find out the true interest rate you get after tax, you have to multiply the interest rate of the account by 0.80%. You can then compare this to the equivalent Cash Isa rate to see which is better. For example, the current best buy for a three-year fixed-rate bond is from Al Rayan Bank at 2.52%, well above the 2.05% offered by Aldermore for its three-year Cash Isa, so it makes sense to go for this if you have not used up your personal tax allowance.
However, if you have exceeded the limit you will be taxed, only earning 1.93%, lower than Aldermore’s Isa.
Stocks and Shares Isas
While a Cash Isa is a tax-free savings account, with a Stocks and Shares Isa you can hold a variety of investments such as shares and funds.
Julian Frere, financial adviser at The Private Office, says Stocks and Shares Isas provide an option for people looking to avoid the erosive impact of inflation on returns.
He says: “Over time there is the potential for better returns with a Stocks and Shares Isa over cash.”
However, he warns that while they offer potential for higher returns, the risks are also greater.
He says: “But are they better than Cash Isas? An investor needs to be comfortable with losses and prepared to invest for at least five years.”
If you are happy to lock away your money for two years, you might want to try Atom Bank’s Two Year Fixed Saver.
This pays 2.3% to savers with a balance of £50 or more, but your money cannot be accessed for at least two years. You can open and manage the account using Atom Bank’s mobile and smartphone app.