Most investors aim to fill their cash Isas before paying into a stocks and shares Isa. That’s because the tax relief
on savings is worth more than the tax relief on investments. For example, a basic-rate taxpayer saves 20% income tax on interest by using an Isa, but gets no special tax breaks on dividend income.
However, recent changes mean that cash Isas are no longer automatically the best deal. First, interest rates on Isas have dropped to the point where it’s possible to get a better rate from a non-Isa account, even after you allow for the impact of tax. Second, the new Isa rules allow money to be transferred freely between cash Isas and stocks and shares Isas. Under the old system, you could transfer from a cash Isa to a stocks and shares Isa, but not the other way round. So there was an incentive to pay into a cash Isa first, to maximise your flexibility over the long run.
Is an Isa the best choice?
Given that, it’s worth checking carefully whether you’d be better off saving into a non-Isa account. There are now a number of current accounts that offer rates that beat Isas for both basic-rate and higher-rate taxpayers. The main limitation of these is that you usually need to pay in a certain amount of money each month. They may also require you to have one or more direct debits set up on the account. However, these hoops are usually not hard to jump through and are worth it for the higher interest rates you can get.
For example, the Santander 123 current account pays 3% interest on balances from £3,000 to £20,000. It carries a £2 per month fee, but it also pays cashback on many household bills, which can more than offset the fee. The Club Lloyds current account from Lloyds Bank pays 4% on balances from £4,000 to £5,000.
You could also consider regular saver accounts that let you pay in a certain amount each month and earn a better rate. Club Lloyds account holders can open a regular saver that lets you pay in £400 a month and pays 4% interest per year. First Direct, M&S Bank and HSBC all offer a 6% regular saver, although you need to have a current account with them.
Get the best deal on your Isa
If you would still prefer to save into a cash Isa, it’s important to get the best deal you can. Low rates mean that the extra gains from shopping around are limited, but the best accounts are still significantly higher than the worst ones: some cash Isas – especially from the major banks – pay rates of well under 0.5%.
You should also check what rates you’re earning on Isas from previous years. It’s common for these to drop over time, as banks hope customers won’t notice. That’s very likely if the rate originally included a short-term bonus. If so, you should transfer these to an Isa that pays a higher rate.
Remember that you must arrange a transfer with the Isa provider, rather than simply taking the money out to pay in elsewhere. If you withdraw the money, you lose the benefit of the past year’s Isa allowance, and it will count as part of this year’s allowance when you pay it back in.
Look for special offers
Also keep an eye out for any special offers. Smaller building societies sometimes provide good deals, but may only take clients from the local area – so check what your nearest ones offer. Do look too for loyalty deals for long-term customers, or bonus rates if you hold certain accounts. Lastly, pay attention to loopholes: Coventry Building Society’s four-year fixed-rate Isa offers a relatively high rate and has a penalty of just 120 days’ interest if you close it early. That’s more flexible than most fixed-rate Isas and means it’s effectively one of the best one-, two- or three-year fixes available.
So if you’re worried rates could drop even lower in the years ahead, this could be a good way to lock in a deal now while still being able to move if rates begin to rise.
Five of the best cash Isas
|Instant access: NS&I Direct||1.5% variable||No restrictions on withdrawals. Operate online or by phone. Does not allow transfers in.|
|Easy access: Post Office Premier Cash Isa||1.5% variable||Allows two withdrawals per year. Operate in branch, by phone or by post. Allows transfers in.|
|Fixed rate: Coventry Building Society Fixed Rate Isa (25)||2.25% fixed||Fixed until 30 November 2018. No early withdrawals permitted, 120 days’ interest penalty on early closure. Operate online, in branch, by phone, or by post. Does not allow transfers in.|
|Large balance: Clydesdale Bank and Yorkshire Bank||2% variable||40 days’ notice needed for withdrawals. Operate in branch, by phone, or by post. Requires balance of £24,000 to get the 2% rate (1% up to £9,000 and 1.5% up to £24,000). Allows transfers in.|
|Regular saver: Newcastle Building Society Big Home Saver ISA||2.57% variable||Pay in up to £1,250 per month. Rate includes 1% bonus, which will be lost in any month in which you do not pay in or make a withdrawal. Operate online, in branch, or by post. Does not allow transfers in.|