In two months’ time there’ll be the biggest savings shake-up for a generation. From 6 April, the new ‘personal savings allowance’ means every basic-rate taxpayer will be able to earn £1,000 interest from all savings without being taxed on it (higher-rate taxpayers get £500).
This takes the sheen off cash ISAs. Their big advantage has always been that you can stash cash where the taxman won’t eat the interest. But now all savings are to be tax-free for 95% of the UK, why bother? Especially as many bank-based savings accounts have rates that make ISAs seem puny.
So the obvious question – is it time to ditch your ISA? Let me take you through it step-by-step…
What is an ISA?
Many overcomplicate it – an ISA is just a savings account you can put £15,240 in per tax year (starts each 6 April) and you don’t pay tax on the interest.
People often confuse it with its predecessor Tessas and think you have to lock cash away for a set time to get tax benefits. That’s not true – you can use it just like a savings account, putting cash in and withdrawing whenever you want.
In fact anything you can do with normal savings you can do with cash ISAs too – so there are easy-access versions, fixed versions and regular saving versions.
The most important point to remember is once you put money in a cash ISA, it stays tax-free year after year.
Sadly though, like all savings, rates are spitworthily low. Even the top-paying easy-access cash ISA pays just 1.51%.
What’s the new personal savings allowance?
Until now, for every £100 interest earned in normal savings, basic-rate taxpayers (20%) only get £80 of it, higher-rate taxpayers (40%) only £60 of it. That’s all about to change from 6 April 2016.
The new personal savings allowance will mean the first £1,000 interest earned in banks, building societies, credit unions and peer-to-peer lenders will AUTOMATICALLY be tax-free. For higher 40% taxpayers it’s the first £500 earned (additional 45% taxpayers don’t get a personal savings allowance) – giving a £200 maximum annual tax reduction for everyone who qualifies.
For a full explanation see the personal savings allowance help guide. Earn under £15,600? Then you already have a tax-free savings allowance called the Starting Savings Rate. If you’ve not claimed it for the 2015/16 tax year, it’s worth doing.
This at current rates will protect 95% of the population’s savings from tax, as £1,000 a year represents a lot of savings…
– You would need to save £71,000 in the top normal savings account at 1.41% for it to generate £1,000 interest (£35,500 to generate £500 at the higher rate).
– You would need to save £33,333 in the Santander 123 bank account, which pays 3%, to generate £1,000 interest. And before fellow money nerds say you can only put £20,000 in it, technically you can open two accounts, provided one is a joint account.
UPDATE: In the feedback to this blog people keep saying “should I open a new personal savings ‘account’?”. I just want to reiterate that’s not correct. It’s a personal savings ‘allowance’ – it’s not a special product. Quite simply all savings will be paid tax-free from 6 April automatically – you don’t need to do anything (unless you go over the limit – more on that in personal savings allowance info).
If all savings are tax-free why bother with a cash ISA?
Even if we ignore the fact that not everyone gets the personal savings allowance, there are still seven reasons why I’d consider opening a cash ISA before just relying on your personal allowance.
- ISAs still have special status. ISA savings are still ‘tax-free’, in other words the interest earned doesn’t count towards your personal savings allowance – so you can better use your savings allowance for other things.
- The personal savings allowance won’t look so generous if interest rates rise. While the allowance looks huge now, if savings rates increase to pre-credit-crunch levels, say 7%, then the £1,000 tax-free interest allowance would be earned on just £14,000 of savings for a basic-rate taxpayer and £7,000 for a higher-rate taxpayer – far less than one year’s ISA allowance.
- Cash ISAs stay tax-free for the long run and you can put serious amounts in. Filling your cash ISA means you can future-proof your savings against tax. Even though rates are poor now, if and when they bounce back, and you earn more interest, an ISA could be very valuable, especially for those who accrue larger amounts of savings.Someone who’d filled their ISA allowance every year since they started in 1999 could now be getting on for £100,000, including interest protected from the taxman.
- Cash ISA rates often beat normal savings rates. Over the past few years the top-paying easy-access cash ISAs have consistently outperformed the top-paying normal savings. So unless the personal allowance skews the market it’s still worth using them.
- Cash ISA fixes have much better terms. Fixed-rate savings require you to lock your money away with no access. Yet cash ISA rules mean providers have to allow you access to your cash, though they can levy withdrawal interest penalties.In the past we’ve seen some corking examples of this, where four-year ISA fixes had such low penalties even if you withdrew the cash early they still beat the best one-year easy-access deals.
There aren’t any of those around at the time of writing, but even so if you are choosing between 2% top fixed savings and a 2% top cash ISA fix the ISA has the advantage that you could get your money out if needed. So everything else being equal it’s a winner.
- Your tax situation may change. Higher-rate taxpayers get a lower allowance than basic-rate, and top-rate taxpayers don’t get it at all. If it’s likely you could move up a tax bracket in future, having cash in an ISA now again protects your cash in future.
- Spouses can inherit their deceased partner’s ISA. So the tax-free status remains, but personal savings allowances can’t be passed on.
It’s worth considering how any of these affect you before ditching an ISA.
Help to Buy ISAs are a no-brainer
Just a quick word before I carry on. The one savings deal that reigns supreme without discussion or debate is the Help to Buy ISA. If you’re a first-time buyer and may one day consider buying a home, this is usually the no-brainer first place to put your cash.
The fact the interest is tax-free is a triviality. The real benefit is that if you use it toward a deposit on your home the Government will add 25% on top, up to a maximum of £3,000. That is unbeatable. If that sounds like you, read my full Top Help to Buy ISAs guide for full info on how it works and best buys.
The top interest is 5% in high-interest current accounts
The really big rates come from bank current accounts which pay loss-leading savings interest to encourage you to switch to them.
Even after tax right now, the interest usually beats cash ISA rates – never mind once the interest is tax-free. Full info and rundown in Top Bank Accounts. Here’s just a selection…
For bigger savers, Santander’s 123 bank account pays 3% interest and up to 3% cashback on household bills – it’s the only one which pays strong rates on a decent whack.
Currently after tax if you’ve £3,000 to £20,000 in it you get 3% interest which after tax for basic-rate taxpayers is 2.4%, still trouncing an ISA, higher-rate 1.8% – which is a smidgeon more than the top one-year fixed ISAs.
Yet once the interest is tax-free, as it will be for most from April, it smashes the pants off any ISA.
However it’s also the only one of the high-interest accounts that has a fee (it rose to £5/mth at the start of this year). But for most that’s more than covered by the cashback it pays on bills. For more details on how the new higher fee affects things see my ditch Santander 123? blog.
Yet even if you didn’t earn any cashback, it’s still a winner factoring the fee in if you’ve over £9,000 currently (£7,000 once returns are tax-free).
If you’ve less, you can earn a higher rate in Club Lloyds, which pays 4% on £4,000-£5,000.
And for smaller amounts there are TSB Classic Plus at 5% on up to £2,000, Nationwide FlexDirect at 5% on up to £2,500 but only for a year, and the Halifax Reward account pays £5 each month you’re in credit, regardless of how much you’ve got.
In summary – so is it time to ditch cash ISAs?
The answer really depends on how much savings you’ve got (and are likely to have). I originally wrote some general thoughts here, but many people requested I spell it out in more detail – so I’ve quickly bashed out a few scenarios to help.
If your total savings are less than the £15,240 cash ISA allowance. There are two factors to understand here…
a) The new personal savings allowance means there’s no tax benefit for you from putting money in an ISA compared to normal savings.
b) If things changed in the future, and you could benefit from putting money in a cash ISA, as you’ve less than the ISA limit anyway you could just do it then.
Therefore, for you it’s simply a case of where will the money pay the most interest. And as currently cash ISAs don’t pay close to the top high interest current accounts as described above – that means most people would be better off ditching ISAs and putting your money there.
Yet, if you didn’t want to open a new current account for the high savings interest, and just wanted a normal savings account, then as the top paying easy access cash ISA pays more than the top easy access savings account; you may as well put it in the cash ISA.
If you’ve a decent chunk more than the cash ISA allowance. Here it is a fine call. Purely on interest, high interest current accounts smash cash ISAs.
Yet be aware that if things changed (eg interest rates increase so the personal savings allowance didn’t cover all your interest) there is a chance you would lose out in the short term, as it would take a couple of years to put all your cash back into ISAs.
Generally though for those with say up to £30,000ish of savings, operating a ‘put it where the interest is highest strategy’ is likely to be the winner as the gain now of high interest should outweigh the risk of some cash not being protected in the future.
- If you’ve got substantial savings. Here it is worth putting/keeping some money into cash ISAs even if you have to sacrifice a little bit of interest to do it – this is primarily to protect yourself from future tax liabilities if interest rates rise (as explained above).Of course a few basic-rate taxpayers, some higher-rate taxpayers and all additional-rate taxpayers will find even at the current limit the personal savings allowance doesn’t cover all their interest – in which case cash ISAs’ tax-free protections are as valuable to them in future as they are now.
Let me know what you will do in the commments below.
NB. A very interesting addendum for finance nerds (so bypass this if that’s not you) pointed out to me by JamesD in the forum. From 6 April 2016 another change is some ISAs will become flexible. This means you can withdraw money and then return it within the tax year (though in general you can only withdraw and then return cash to the provider you withdrew from – though there are some complexities).
This means it looks like it will be possible to play the system (if ISA providers play ball). For example let’s say you have £50,000 in ISAs, but bank accounts pay higher interest, and you don’t want to lose your ability to keep £50,000 in a cash ISA.
What you could do is at the start of the new tax year so say 6 April, withdraw some from an ISA, eg £40,000 and put it in a high interest bank account. Then on 4 April the following year just put it back in the ISA for two days to keep your allowance alive then withdraw it again etc. I’ll do more info on this nearer the time once I’ve dotted all the Is and crossed all the Ts.