Using an ISA means you’ll be able to earn interest on your savings without paying tax on them. It’s a win-win solution for savers. Unfortunately, historically low interest rates mean even without tax, it’s pretty much impossible to get a saving rate that can beat the current rate of inflation. This is why it could be time to think about moving your money into another savings or investment vehicle with potentially higher returns.
The benefit of saving into an ISA is that you can earn interest tax-free, but it’s not the only way. Thanks to the introduction of the Personal Savings Allowance, most basic rate taxpayers will not have to pay tax on the interest they earn until it exceeds £1,000. Higher rate taxpayers have a £500 allowance while additional rate taxpayers have none at all.
Money saved into an ISA will escape tax no matter how much you earn in interest.
So even if the Savings Allowance means you currently escape tax on interest, if the Bank of England raises rates, or your earnings rise, it could see you become liable in the future.
Given the ISA allowance for the 2020/21 tax year is £20,000, people with a lot in the bank would struggle to move all their money into an ISA in a single year to beat the taxman.
By saving into one now, you can skip that problem entirely.
No, ISAs do not always pay the best interest rates. Historically, to beat an ISA you would need to find a net interest rate on a savings account that was higher than an ISA's gross interest rate.
Net interest represents the rate you get on your savings after tax has been deducted. The gross rate is what you get paid before tax.
Now, all banks and building societies use gross interest to advertise their savings accounts. This means you can compare ISAs to other accounts on a like-for-like basis.
In times of low interest, ISAs aren’t always the best place for your savings. This is because the amount of interest you can earn, which is linked to the Bank of England’s base rate, doesn’t always beat the rate of inflation. This means you could be losing money by keeping your cash in an ISA.
Although you have more tax-free savings options available to you, ISAs are still used by many people to create innovative accounts to help you in the future.
There have also been new types of ISA launched, designed to help people meet specific savings goals.
Lifetime ISAs: Like the old Help to Buy ISA, it gives you a 25% bonus on the first £4,000 you save each year provided you use the cash to help buy your first home or wait until you turn 60 to access it.
Junior ISAs: These are special ISA you can open on behalf of your child. They have their own ISA allowance (£4,368), and cannot be touched until your child turns 18 years old.
ISAs are also seen as a safe option for your money. This is because any money kept in a cash ISA is protected and if you need it, you are able to take the money out. If you’ve put the money into an investment vehicle instead, there is a risk you will lose it.
There are also benefits for your spouse or civil partner because if you die, they can inherit your ISA allowance for that year.
If you're prepared to put your savings at risk in hope of a greater return, and still want to use your ISA allowance, you could consider one of the following:
Also known as a stocks and shares ISA, it lets you invest with your ISA allowance but keeps your growth tax free.
Also known as a P2P ISA, it lets you use your ISA allowance to invest in peer to peer lending.
You cannot use the Personal Savings Allowance with investments or P2P lending, but you can use your ISA allowance to make them tax-free.
Speak to an independent financial adviser if you are unsure if an investment is right for you.