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Get 5% interest on your ISA money

Get 5% interest on your ISA money

Get 5% interest on your ISA money

The new cash ISA year started yesterday. Our best pick pays 2.75%, but some bank accounts pay up to 5% interest (before tax) as loss leaders in order to pull money in. So while savers’ money is generally nicer in an ISA in the long run. In the short term, the bank accounts win. Yet there is a way to get the best of both worlds…

As many have asked me which wins, cash ISAs or bank accounts? I wanted to bash out a logical path through this conundrum. To establish which is best, we first need to look at both contenders for your savings cash (or jump to ‘The best of both worlds’).

Contender 1. The top bank accounts pay up to 5% BEFORE tax

Bank accounts were once the worst place to stash cash, paying diddly-squat. Yet with savings rates at all-time lows they’ve seen an opportunity to use high rates to flog current accounts. So now, provided you’re willing to switch account (or you may already have one) they’re top interest payers.

Which one to choose depends on how much cash you’ve got (see the table below). You should focus on covering more of your money at a decent rate, rather than going for the one with the highest rate. For example, if you’ve got £12,000, Santander’s 3% beats Lloyds’ 4%.

For comparison, the top easy-access savings deal pays just 1.5%.
Current account In-credit interest (AER) After basic tax After higher tax Max interest each year (1) Intro bonus
Santander 123 (2) 3% on whole amount if you’ve £3,000-£20,000. Plus up to 3% bills cashback 3% becomes 2.4% 3% becomes 1.8% £450 (after fee) -
Club Lloyds 4% on whole amount if you’ve £4k-£5k (3) 4% becomes 3.2% 4% becomes 2.4% £157 -
Nationwide FlexDirect 5% up to £2,500 for 12 months, 1% after 5% becomes 4% 5% becomes 3% £98 (year 1) -
TSB Plus 5% up to £2,000 5% becomes 4% 5% becomes 3% £78 -
Halifax Reward £5/month as long as you stay in credit The £5 is after basic tax £3 (you’ll need to state the interest on your tax return) £60 £100
First Direct 1st Account None n/a n/a None £100
(1) Estimated post basic tax interest, if you always held the max balance or more. (2) Has £2/mth fee, but for most, cashback more than covers it. It pays 1% savings interest on £1k-£2k, 2% on £2k-£3k and nothing on above £20,000. (3) 1% under £2,000, 2% on £2k-£4k.

While the amounts here are limited, it is possible in all cases to open two of the same account (four with TSB), though in all cases one (two with TSB) must be joint accounts. But doing this is fiddly and you normally need to ensure you meet the minimum pay-in with each. Some accounts also require you to pay direct debits from each account.

Contender 2. The top pick cash ISAs pay 2.75% AFTER tax

A cash ISA is just a savings account where you don’t pay tax on the interest. From this tax year, which started yesterday, you can put in £5,940. However from July when the new NISA starts, you’ll be able to top this up to £15,000. From this point on I’ll assume you understand cash ISAs, if not please first read the full Top Cash ISAs guide.

  • Top easy-access – 1.6%. To compare like for like with the top bank accounts we need to look at the top easy access cash ISA (as all the bank accounts are by definition easy-access, meaning they don’t require any notice to take your cash out).

    Here, the winner is Santander’s 1.6% AER variable Direct ISA (minimum £500), which lets you put new money in and transfer old ISAs to up the rate.

  • Yet most people can earn 2.75%. People often plump for easy-access out of nervousness that they will need the cash. Yet unless you definitely need it and need it soon, you can earn much more in a fixed ISA – as unlike fixed savings accounts – by law they have to allow you access to your cash. They can however levy interest penalties for early withdrawals.

My top pick is the Coventry BS 4-year 2.75% cash ISA (min £5,760, no transfers) which allows you to close the account and withdraw early for a relatively low penalty, just 120 days’ interest.

A number crunch shows if you withdraw after a year, you’d effectively have got 1.85%, beating the best easy-access deals. After two years it’s 2.3%, beating the best two-year fix, and after three years, 2.45% which beats the other 2.25% best buys.

So which wins? Bank accounts or cash ISAs?

On rate, even after tax the top bank accounts ALWAYS beat the best easy-access deal, and some beat the top fixed deal too.

So if you’re only planning on having cash in an account for a short time – go for the bank account. However that isn’t the end of it, as I touch on in my Santander 123 v cash ISAs blog published in the last tax year, two weeks ago. You need to factor in the long term ISA gain.

While the interest given by bank accounts is usually ‘variable’, which means it can change due to interest rate moves or simply at the provider’s whim, most will tend to keep their offered rate for a while although at some point it’s likely they’ll reduce it closer to normal savings rates.

So the gain of cash ISAs is longer term. Of course easy-access cash ISA rates are variable too, but putting money in an ISA now means it’s not just tax-free this year, it remains tax-free year after year. So even if your provider’s rate drops, you can do a cash ISA transfer to shift it to a different account and retain the boon of its tax-free status.  

This means the benefit of stashing cash in an ISA each year is very important, especially for those with larger savings. In the long run when interest rates bounce back, you will then gain substantially from having as much of your savings as possible protected from tax.

So it is worth considering doing that even at the cost of giving up the short term interest rate boost from the loss leading high interest bank accounts.

The best of both worlds

There is a half way house solution for those who want to get the long term gain of filling up their ISA allowance to maximise tax free savings, and take advantage of the short term high rates offered by bank accounts – you can do both.

  • Step 1: Shove cash into the high interest bank account. Do this right now rather than open an ISA and don’t use your 2014/15 cash ISA allowance.

  • Step 2: A week before the ISA year ends, use the cash to open one. At the end of March next year – just move the cash out of the bank account and then open your ISA to fill the allowance.

This way you get to protect your cash from tax in the long term, but gain the higher, short-term interest now.

The government’s energy changes mean fewer people will switch

The government's energy changes mean fewer people will switch

The government's energy changes mean fewer people will switch

The energy regulator Ofgem has today announced it is proposing to refer the energy market to the competition authorities. This report, which is only five years too late, contains the ‘shock’ fact there’s tacit co-ordination on energy prices – even though each year energy firms bleat like sheep and raise prices together.

Within the report, a key concern is the lack of competition and consumers switching. Yet it’s important to understand that both the government’s policies, and indeed Labour’s price freeze will have the net effect of massively reducing the numbers shifting to new energy suppliers.

Please don’t automatically read that as a criticism of the policies. Both parties aim to reduce the price (or at least reduce the increases in price) for the majority of people; but the majority of people don’t switch. Therefore what’s good for most isn’t necessarily good for switching.

So I thought I’d bash out a look at the key recent changes and the impact they’ll have on switching…

  • A reduced number of tariffs lessens pricing differentials.

    For the sake of transparency and simplicity the government has legislated that energy firms can only have four main tariffs.

    The net effect of this is a homogenisation of prices – in other words, we narrow the gap between the typical tariff and the cheapest. This is good news for many – it means 90-year-old grannies with no web access no longer pay quite so much as someone like me to boil a kettle.

    Yet as was very predictable (in fact I did predict it here) narrowing the differential decreases the gain from switching. So now I talk of someone on a typical tariff saving up to £150 a year, where in the past it was £250 or £300.

    This very obviously diminishes the switching appeal, although I’d still say it’s worth it as it only takes a few minutes – see Cheap Energy Club – but we can already see people are less keen to move when gains are smaller.

  • Price freezes mean people don’t switch.

    Nothing makes people switch more than price hikes. It acts as a call to arms. The last switching season (at the end of 2013) saw mammoth switching volumes. But as soon as that’s over, it’s very difficult to get mass switching action until another moment of price flux.

    Labour’s call to freeze prices, the governments reduction in green tariffs, the fact most energy firms have said they don’t intend to increase prices this year and SSE’s promise to freeze prices until 2016, quite simply means switching volumes will be tiny.

    In fact, this is counter logical, the best time to switch is now, when there is price stability as you get a more accurate comparison. Yet in general the public doesn’t react that way.

  • So in fact, freezing prices can mean some pay more as they accept the status quo rather than actively choose the market’s leading tariff. Though of course, if freezing prevents hikes for the majority – who wouldn’t switch anyway – there is a net gain.

  • Ofgem’s recently banned cashback switching incentives.

    While this is more minor, I do find it frustrating. It did this as a worry that people would be encouraged to move to an expensive tariff to get the upfront cashback. Somehow it missed the fact that some may’ve also been encouraged to move to a cheap tariff because they get cashback upfront.

    The right solution would’ve been to improve the way cashback and pricing was communicated, not to remove a switching incentive.

    Bizarrely though, it has decided that voucher incentives are fine. So a firm can’t give you £100 cashback, but it can offer near cash £100 Love2Shop vouchers, which can be spent in a huge range of high street stores. I’m not quite sure how different that is.

    At one point it looked like comparison site cashback switching would be banned too, but we successfully managed to argue to keep this as it applies across a large range of tariffs rather than a specific tariff (hence why Cheap Energy Club can still give £30 cashback and other comparison sites can too give cashback incentives via our special links).

Again, let me stress that (barring the cashback rule), I’m not saying I necessarily disagree with the policies, just that we need to acknowledge that if you set switching as a key performance indicator, you have to incorporate the impact of policy changes.

There are a couple of potential switching boosters. New smaller suppliers will garner support from more sophisticated consumers who want to make a deliberate stance to avoid the big six, although it’s important to note that on price these suppliers aren’t (and possibly with the current market structure aren’t able to be) necessarily cheaper. Perhaps the split of energy company vertical integration will help that.

There’s also the push towards collective switching where a trusted intermediary or local agency negotiates a deal with an energy supplier then gets people to sign up. It’s a great principle, the problem is that so far not one collective switch has been market leading on price – comparison site best-buys still beat them and I don’t see that changing. 

For example, we now have over 1m members of the Cheap Energy Club, yet big suppliers are simply unwilling to offer market leading deals without terrible conditions such as "you can’t then contact consumers for three years after the cheap fix ends to say switch again". We will keep looking for a good one though.

Yet these switching boosts are minor compared to the other factors so overall, I suspect we will see hugely reduced switching volumes in 2014 compared to 2013.

The Chancellor’s pension changes are both wonderful and horrid

The Chancellor's pension changes are both wonderful and horrid

The Chancellor's pension changes are both wonderful and horrid

In this week’s Budget, the Chancellor announced the most sweeping changes to pensions for years. From 2015, everyone will have the option to access their cash without having to buy an annuity – the product you buy to convert a pension pot into a regular income for the rest of your life. I am completely torn over this policy. There’s no middle ground, it’s either wonderful or horrid.

In a nutshell, from 2015, at the age of 55 you’ll be able to take 25% of your pension savings as a tax-free lump sum and can then access the rest when you need it, but paying standard income tax when you draw that money out. 

For example, at current rates, if you had £200,000, you could take £50,000 out tax-free at 55 (or later), and then if you chose to take the remaining £150,000 out, paying tax on it as if it was income. For a full explanation, see the Pension changes news story.

That wouldn’t be so clever, as it’d push you into the 40% tax band and you’d lose a good chunk of the money (or if you had other income, it’d be the 45% tax band). So instead, what you’d likely do if you wanted to get all the cash out and minimise your tax liability, is withdraw just up to the 40% band (c.£45,000) each year until you’d taken it all.

  • It’s wonderful because… For savvy, financially responsible individuals it allows you the complete freedom to use your pension fund in the best way possible. This could be to repay your mortgage, or it could be to clear expensive credit card debts.

    This has long been the complaint about annuities – it locks you into a product that’s poor in comparison to the other alternatives you can choose to use for your money.

    You could choose, as I suspect (too) many will, to invest it in a buy-to-let property to hopefully generate capital growth or income. Done right, this is far better than the current arrangements.

  • It’s horrid because… Many people are financially uncertain and confused. Already in the annuity market, a huge 60% of people just grab their pension firm’s annuity offer, rather than finding the best rates. As you then lose out each year for the rest of your life, the cost of this mistake can be huge, eg, £11,000 lost on a £100,000 annuity purchase for someone living 25 years.

    So allow me a good old fashioned bit of paternalism; how do we expect the same people to make the right choice when there are even more options and choices? Never mind the not insignificant group of people struggling with mental health issues or the onset of dementia. 

    To make a decent decision, you need to know roughly how long you are likely to live at retirement and what the effective returns are on your money. 

While financial freedom of choice is a great boon for the savvy, for the mass who are typically scared of finance, as well as making the wrong financial decision there’s a further dual worry. Some will splurge too soon and leave themselves with nowt for their dotage. But just as many will nervously keep it in their current account, never spending and depriving themselves of the benefit out of over caution.

This juxtaposition is one I am wrestling with. The Chancellor has said he wanted to give everyone access to independent advice to help them decide. This is a great idea – I always suggest using an independent financial adviser before taking out an annuity – yet most IFAs won’t touch people with small pension pots (that’s not an attack, just a fact, the structure doesn’t let them run their businesses if they do).

However, to combat this, the Chancellor has said he’ll put aside £20m over the next couple of years for face-to-face advice. Though we’ve scant details on what that really means. Yet on a back-of-an envelope calculation, with infrastructure costs we will be lucky if we’ll get 200 advisers working on this – that’ll hardly touch the sides.

So I’m still wrestling. Many of the comments from members of the public I’ve read on this are in favour. Then again, to comment on this means you understand it, which means you are in the group of financially savvy who will gain. The voices of those who don’t understand it are far quieter – so it’s tough to judge the real public view. 

The remaining question is: how do we enable pension freedom for those who want it, while protecting those who may misunderstand how to plan for themselves? I’d welcome your views…

Thanks London, but I don’t want to be Chancellor, nor am I qualified to be (though who is?)

Thanks London, but I don't want to be Chancellor, nor am I qualified to be

Thanks London, but I don't want to be Chancellor, nor am I qualified to be

A piece in the Evening Standard this week highlighted that Londoners had picked me as their no.1 choice to be Chancellor. I tracked down the origins of this to an Opinium survey of 1,000 Londoners press-released by Nutmeg, which includes…

When asked from a pre-defined list who respondents would replace George Osborne as Chancellor with if they could, the most popular figures were:

•         Martin Lewis (15%)
•         Richard Branson (12%)
•         Alan Sugar (7%)
•         Ed Balls (6%)
•         Boris Johnson (5%)

Now I won’t use the same line as I did last time this happened (see my 1 in 4 say they want me to be Chancellor – do they hate me that much? blog post).

But while I appreciate the faith people have in me, I’m afraid I think it is misplaced. I suspect the reason I come top is that within my work I am entirely biased towards consumers. I don’t balance the interest of businesses at all (hence the stick I often get from travel agents, retailers, etc, for ignoring "the impact on us").

The UK’s Chancellor doesn’t have such luxury. (S)he must look at all the interests out there – consumers, high earners, benefit recipients, businesses, charities, public services, overseas investors and more, to ensure the economy is functioning as well as it can for the population.

I suspect were I made Chancellor, as I’d need do this too, within six months people would say "you’ve changed, you’re just as bad as the rest of ‘em".

And let’s be honest here, my consumer finance work leaves me far from qualified to run an economy. I’m not an economist, I don’t pretend to be. It’s a very different discipline to what I do. 

Having said that, I’m not sure even being the world’s best economist would make you a great Chancellor, as ultimately at the big end, much of the finance world involves random elements and chaos. So who is truly qualified?

As a final note, personally I couldn’t think of anything worse than being Chancellor or any form of Westminster-elected politician. To do a job where by definition you have people whose job it is to oppose you feels pretty soul-destroying to me.

Does the Santander 123 3% interest beat the top cash Isa?

Does the Santander 123's 3% interest beat the top cash Isa?

Does the Santander 123's 3% interest beat the top cash Isa?

UPDATE 7 April: As it’s a new tax year the logic of this has slightly changed. Please read my Get 5% interest on your ISA money blog for more info.

Isa season is nearly upon us. That’s the frenzied time around the 5 April tax year close, when many are desperate to get an Isa set up before the tax year deadline, and then a whole load more people open Isas on the new tax year’s first day.   

Normally providers boost rates around this time, though this year there’s such little competition I suspect that’ll be muted.  

However there’s a rather strange dynamic to the whole 2014 cash Isa question. While the top easy-access Cash ISA at 1.75% AER easily beats the top normal savings at 1.5%, a hidden contender threatens to disrupt the usual logic. 

For those willing to switch their bank account, the Santander 123 account pays a whopping 3% easy access interest, provided you’ve got between £3,000 and £20,000 saved in it.

As many have asked me which is better, I thought I’d bash out a quick answer.

Update 1 April: Since writing this blog, a couple more top paying bank accounts have launched with up to 5% savings interest – the principles below apply in exactly the same way to them too.

Santander 123 v cash Isas

I’m assuming you understand the cash ISA basics, if not, please click the link and read that explanation first. Also, this blog is aimed at those familiar with the Santander 123 account. If you’re not, it’s worth noting it does have a £2/month fee. However for most users, that’s more than covered by the cashback it gives if you pay bills via it. See my Santander review for more.

  • On rate, Santander wins for almost everyone

    With pre-tax interest of 3%, a basic rate tax payer gets 2.4% after tax in Santander, a higher rate tax payer 1.8%, and for a top rate payer (those earning above £150,000) you get 1.65%. 

    The top easy access cash ISA, where of course no tax is taken off the interest, pays 1.75% to everyone. So purely on the rate, both basic and higher rate tax payers are better off putting their money into Santander 123. 

  • Santander 123′s rate may not last forever

    Santander 123′s interest rate is ‘variable’, which means it can be changed both due to interest rate moves or simply at Santander’s whim.

    While I think severe changes are unlikely in the short term, I doubt this loss-leading deal designed to encourage people to churn bank accounts will still be paying double the best easy-access savings rate in a few years’ time.

  • Putting money in a cash Isa has a long term gain

    Easy-access cash Isa rates are, of course, variable too. Yet the gain of putting your money in an Isa now means it’s not just tax-free this year, it remains tax-free year after year.

    So even if your provider’s rate drops, you can do a cash ISA transfer to shift it to a different account and retain the boon of its tax-free status.

  • You can get a fixed rate cash Isa to pay more

    If you’re prepared to lock your money away, you can get a fixed rate cash ISA paying up to 2.75% (that one is for three years), which for all taxpayers will beat Santander after tax.

    It does, of course, lack the flexibility of you being able to withdraw cash (technically they have to let you withdraw, but there are hefty interest penalties if you do).

Which to choose…

It really comes down to how much in savings you have.

– Under £3,000: You can’t get 3% in Santander 123 anyway, so that’s irrelevant.

– Over £25,000: You can fill both an Isa account and Santander’s 123 account, so there’s no need to choose.

Therefore the real decision comes for amounts in between.

  • If you’re likely to be able to fill your Isa allowance most years…

    The more likely you are to get close to filling your cash Isa allowance this year and next year (you have a max £5,760 this year and £5,940 next year), the more you should hedge towards prioritising doing just that.

    There is a real gain to building up a pot of savings protected from the taxman, and in years to come, when rates bounce back, the more you’ve got stashed under the Isa’s protective cover the better – even for a short-term sacrifice of rate. And if you don’t use it before 5 April, you lose it.

    This is especially true for those likely to continue to be able to stash more away in savings year after year.

    However, if that leaves you just short of hitting Santander’s £3,000 minimum threshold to get the 3%, I suggest you don’t quite fill your Isa to ensure you get over that threshold.

    This is because if you have £2,999 in Santander, you get 2% on the WHOLE amount, but if you have £3,000 you get 3% on the WHOLE amount, so that extra pound does you very well.

  • If you’re unlikely to fill your Isa allowance every year.

    In this case, hedge more towards getting the short-term interest rate gain of Santander. This is because you’ll still have room to shove money in a cash Isa if that becomes competitive in the future, simply because you won’t have filled your allowance.

So overall you can see it’s a balance. However it’s worth noting if you are considering removing money from an old Isa to put into a Santander 123 account, then I’d be careful. Let’s say you take £20,000 out of your old Isas – if you wanted to get it back in at some stage in the future, with current Isa limits, it would take you four years. So if you’re planning on doing that, do really weigh up whether the short term gain is worth it.

PS. Similar logic to this applies for smaller amounts in Nationwide’s 5% bank account and Lloyds’ Vantage account. See Best Bank Accounts for a run down of the high interest current accounts.