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Is saving money in a cash ISA still a good option after tax rule changes and plummeting interest rates?


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Putting your money into a cash ISA used to be a really sensible option for those saving even moderate amounts of cash – but changes to the tax rules and plummeting interest rates have left these products out in the cold.

Figures from financial data experts Moneyfacts show that there’s now a large gap between the best paying cash ISAs and similar savings accounts that do not have the same tax perks.

‘ISAs are still worth considering to take advantage of their tax-free status, but over the years they have lost their appeal,’ says Rachel Springall, a finance expert at Moneyfacts.

The latest figures from the taxman show that the number of people opening new cash ISAs or adding to new ones had dropped from more than 12 million to 8.4 million by the 2018-19 tax year. But despite the low rates on offer, more than three times as many people opened or contributed to cash ISAs than to the stocks and shares equivalent.

Whether the choice is between a cash ISA and another type of cash savings account, or between a cash ISA and a stocks and shares ISA, experts advise you to ensure you understand the pros and cons of each in order to make the most of your money.

Here’s how to weigh up the options.

Cash ISAs – low rates vs tax breaks

One reason that cash ISAs have lost their appeal is that interest rates lag behind other accounts. Rachel at Moneyfacts points out that with fixed accounts, particularly, the rates you can get for cash savings outside of your ISA are far higher. The best rate for a five-year fixed rate ISA is 1.15 per cent, with Shawbrook Bank, compared with 1.4 per cent for an ordinary fixed rate savings account with Gatehouse Bank.

‘Rates on ISAs have fallen and failed to improve where other accounts have remained more competitive,’ Rachel says.

‘Savers’ expectations of an ISA season will continue to wane in 2021 as rates plunge and some providers pull their deals entirely.

‘There does not appear to be any promising signs of competition, as average rates have reached new lows,’ she adds.

But the other reason why cash ISAs are less popular is the introduction of a new tax break, which makes the tax-free status of cash accounts less valuable.

The main appeal of a cash ISA is that the interest you earn on your savings is not taxed, but the Personal Savings Allowance (PSA) means that many of us do not pay tax on our savings interest anyway. The (PSA) allows basic rate taxpayers (those earning less than £50,000 this tax year and £37,700 next tax year) to earn £1,000 in interest from cash accounts every year without paying tax on it. Those paying a higher rate can earn £500 a year in savings interest without tax. Only additional rate taxpayers (earning more than £150,000) do not have a personal savings allowance.

With savings rates at current lows, most of us would need a huge amount of savings in cash to use up our entire PSA. A basic rate taxpayer, for example, would need to have savings of more than £70,000 to receive interest of £1,000 a year at 1.4 per cent. Even a higher rate taxpayer could have £36,000 in savings before having to pay any tax on this interest.

This makes the immediate need for cash ISAs far less obvious. ‘With an ISA, make sure you actually need the tax efficiency,’ says Philippa Gee of Philippa Gee Wealth Management.

Why big savers will find ISAs nicer

With many of us having increased our savings balances during the pandemic, though, the need for cash ISAs may have increased. According to the Bank of England’s latest figures, household savings have risen substantially during the pandemic, with 70 per cent of those who had increased their bank balances saying they were planning to continue to hold the money as savings rather than spending it.

Figures from Killik & Co found that ten per cent of 40 to 59-year-olds had saved into a cash ISA during the pandemic, a greater proportion than had paid into their pension. Those whose bank balances have increased need to check whether they may end up paying tax on their savings income if they do not put money in an ISA.

This issue will only be exacerbated by the government’s decision to freeze the higher rate tax threshold at £50,270 until 2026, meaning that more people will fall into the higher rate tax bracket, losing the right to the £500 of tax-free savings income.

Once money is in an ISA it is protected until you take it out, meaning that you can build up a huge amount of savings in these accounts over time using your £20,000 a year ISA allowance.

Making the most of your Isa allowance

If you want to get the most out of your ISA allowance of £20,000 this year, you may want to weigh up the pros of putting the allowance in cash against putting it in stocks and shares.

You can hold ISAs of both types and can switch between the two, even with older products, which means you can change your strategy whenever you wish.

Simon Crookall, the founder of Gumtree who has recently founded investment platform InvestEngine, says that there are benefits to going the stocks and shares route.

‘If you put £100 every month into an account paying 0.1 per cent for the next 25 years, you’d end up with £30,390. Contrast that with investing the same amount in the stock market where potential returns might average five per cent a year, and you’d end up with £58,811 — potentially near double what you’d have from cash,’ he says. ‘Britons have squirrelled away £125 billion in savings accounts during the past year’s lockdowns — more than £4,000 per household on average.

‘For those who don’t need to keep this cash on hand — or plan to spend it post-lockdown — investing in a stock and shares ISA could be an ideal home for this nest egg.’

The final decision

Not everyone is comfortable with investment, and those with larger savings balances will need the tax shelter given by an ISA over time.

If you decide a cash ISA is for you, use the rates in the table below to find out the best deals available. All of the ISAs below accept money transferred from other ISA accounts so you can ensure that your earlier savings aren’t languishing at low rates as well.

As the tables show, the longer you are willing to lock up the money for, the better the deals will be.

If you only have a small amount of savings, though, the best-paying cash accounts are not ISAs. They include a regular savings account from NatWest at three per cent for current account customers only, and a 0.85 per cent 95 day notice account from ICICI Bank.

The cash ISA may not be dead, but it is certainly no longer the obvious decision it used to be, so weigh up all of these factors very carefully before deciding where to put your savings.

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Get in touch at metrolifestyleteam@metro.co.uk.

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