Whether you have a cash ISA or are thinking of getting one, you need to know if it's still a good place to invest your money. Here is how to work out if ISAs are worth it for you.
Using an ISA means you can earn interest on your savings without paying tax. It’s billed as a win-win solution for savers, but that’s not always the case.
Unfortunately, it’s impossible to get a cash ISA savings rate that beats the current rate of inflation (6.7% at the time of writing). This means the value of your savings is eroded over time and your money will buy you a little less each year.
This is one reason it could be time to think about moving your money into another savings or investment account with potentially higher returns.
The second reason ISAs have been called into question is the Personal Savings Allowance provided to UK residents by the government. This lets basic rate taxpayers earn up to £1,000 in interest a year without paying any income tax.
This means most people can save into a normal account without tax consequences, so if you see savings products offering higher interest than ISAs, they are certainly worth considering.
However, there are still some circumstances where a cash ISA remains a good choice.
Money saved into an ISA is income-tax free no matter how much you earn in interest.
The rules for money in other savings vehicles are more complicated. For instance, if the Bank of England raises rates, it could push you over the Savings Allowance, which would mean you have to pay tax.
Equally, if your earnings rise and you’re pushed into a higher tax-bracket, your Savings Allowance will get smaller or even vanish, leaving you with a tax bill. This is particularly relevant as the UK Government has frozen tax bands for the last four years, effectively “dragging” more taxpayers into higher tax bands.
Each year, you get a new ISA allowance. The maximum you can save in ISAs for the current tax year is £20,000. You can’t carry allowances over, so if you think you might move into a higher tax bracket or breach the Savings Allowance, it’s worth considering transferring your savings into ISAs sooner rather than later.
Cash ISAs are covered by the Financial Services Compensation Scheme (FSCS). This means that you are protected up to £85,000 per person, per regulated firm.
You can only pay into one cash ISA at a time. But you can open a new one and start saving there when the new tax year begins and transfer savings from one provider to another (if the new provider allows it). It’s always worth shopping around at the beginning of the tax year to find the best rate possible, but if you’ve got significant savings, you should also make sure that you only have £85,000 per firm, to ensure that you are fully protected.
Cash ISAs are savings products, which means your capital is safe, and you get paid interest. You can choose a fixed rate, where the interest rate is guaranteed for a fixed term, or variable rate whether the interest you earn can rise and fall.
There are several reasons you might choose a cash ISA.
If you have a large enough savings pot that you’ll earn more than £1,000 in interest each year, then an ISA is a good idea to protect you from income tax
Higher rate taxpayers only get a £500 Personal Savings Allowance, making ISAs an appealing option for people with smaller savings pots as the limit will be reached more quickly
Additional rate taxpayers don’t get any personal savings allowance, making cash ISAs a great choice for short-term, easy-access, and emergency savings
However, most people do not have enough saved up to breach the personal savings allowance. If that’s the case for you, then you want the best returns possible and should shop around for the highest savings interest rate available. You won’t pay income tax on any interest earned anyway, so don’t need the ISA benefits.
There are also some specific types of cash ISA that are designed to help you meet various life goals. These come with other perks, so are worth considering.
Lifetime ISAs (LISAs): You can use LISAs to save up to £4,000 annually, with the government adding a 25% bonus (up to £1,000). As with cash ISAs, you can only invest in one LISA per year, but you can open a new one each tax year and you can shift funds to a different provider to take advantage of the best savings rates. You need to be aged between 18-40 to open one and you can only use the money to buy your first home or for your retirement
Junior ISAs: These are special ISA you can open on behalf of your child. They have their own ISA allowance (£9,000) and the money cannot be withdrawn until your child turns 18 years old. The tax advantages are particularly worth considering for parents saving for their children as this can have income tax implications
Cash ISAs are safe because any money kept in a cash ISA is protected and if you need it, you can take the money out – immediately if you choose an instant access account. If you put the money into an investment vehicle such as a stocks and shares ISA, on the other hand, there is a risk you will lose it.
Choosing a cash ISA may also benefit your spouse or civil partner if you die, as they can inherit your ISA allowance for that year.
No, cash ISAs do not always pay the best interest rates, so it’s worth shopping around.
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 and high inflation, ISAs aren’t always the best place for your savings. This is because the amount of interest you can earn, which is often linked to the Bank of England’s base rate, usually doesn’t beat the rate of inflation.
As prices rise, your savings will be able to buy less and less, eroding their real value over time.
Once you've signed up to an account, don't assume you'll keep getting that rate forever.
Some accounts include bonus interest for the first year that then drops away, while others only pay the advertised rate for a set period, before dropping off hard.
And that's before we get to variable rate accounts - which rise and fall depending on interest rates elsewhere in the market.
If you're worried that you're getting a poor deal, you can check out the top rates currently on the market by following the link below.
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.
There is no equivalent to the Personal Savings Allowance with investments or P2P lending, so using an ISA keeps your returns tax-free.
Speak to an independent financial adviser if you are unsure if an investment is right for you.
It depends on your personal situation, how much you have saved, and your tax bracket. Typically, you want the best returns possible, which often means a savings account instead of an ISA. But if you’re a high or additional rate taxpayer, or you have a substantial sum of savings, you may need the tax advantages of an ISA.
Higher-rate taxpayers only get half of their Personal Savings Allowance (£500). If you’re going to earn more than that in savings interest, then an ISA will protect you from income tax.
Additional rate taxpayers don’t get a personal savings allowance, so a cash ISA is a good idea for short- and medium-term savings.
If your savings interest rate is lower than inflation, the value and purchasing power of your pot is eroded over time. This is true whether it’s in an ISA or a traditional savings account. For short-term goals such as an emergency fund or a holiday, ISAs and savings accounts can still be a good place to save up. For long-term savings such as retirement, however, you should consider investing to help your money grow over time.
If you have a cash ISA, it won’t be losing money (even though inflation can erode your purchasing power, as explained above). You’ll earn interest on either a monthly or annual basis. Investment ISAs are invested, which means their value fluctuates. However, you haven’t “lost” anything unless you take the money out. The value of your shares will change daily, and a well-diversified portfolio should increase over the long-term. That’s why stocks and shares ISAs are not usually recommended unless you can leave the money invested for at least five years.