UPDATE 20 FEB 2015: Read a fully updated 2015 version of Should I save in an ISA or Santander 123 blog?
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.