Getting the best deal on your cash Isa

Cash Isa chart

Which types of Isa will you definitely or probably be contributing to in the 2017/2018 tax year?

Stocks and shares Isas are the most popular choice for MoneyWeek readers. Most readers are over 40, so it’s not surprising that demand for Lifetime Isas is limited, but some of you also plan to pay into one on behalf of your children.

There is no denying that cash Isas aren’t as attractive as they used to be. In the past, these accounts had the double attraction of a good interest rate and tax-free returns. Today, interest rates are pitiful – the average is just 0.81%. And most people now get tax-free returns on their normal savings accounts anyway, thanks to the personal savings allowance, which was introduced last year. So is it still worth bothering with cash Isas?

For many savers, the answer is yes – as reflected in the fact that almost a fifth of MoneyWeek readers expect to pay into a cash Isa in the next tax year. It’s true that the personal allowance is attractive for basic-rate taxpayers, who can earn up to £1,000 a year in interest on their savings before tax is due. But if you are a higher-rate taxpayer that allowance is slashed in half to £500. Additional-rate taxpayers get no allowance at all. So if you already earn close to the next tax bracket and you get a pay rise, your personal savings allowance is slashed and you could suddenly owe more tax. Stick with cash Isas and that isn’t a worry.

What’s more, interest rates won’t stay low forever. And once they rise, the £1,000 or £500 per year allowance won’t stretch as far as it does at present. The attraction of Isas is that if you put your cash into them now, it’s sheltered from tax for as long as it stays there. If you had saved the maximum Isa allowance each year since Isas were introduced in 1999, you could have built up savings of almost £125,000, assuming average annual interest at 3%. If that money was sitting in a savings account, and earning just 1% interest, you would owe income tax, since you would be earning more than the allowance.

In an Isa, it’s tax free – and will still be tax free even if rates go back to 3% or more. Another bonus for long-term tax planning is that the account can pass to your spouse when you die. That means if you build up a sizeable fund, it can continue to grow tax-free after your death.

Getting a better rate

The main problem with cash Isas is that interest rates are so meagre, in common with most savings accounts. This means that unless safety is your top priority or you are likely to need plenty of cash in the next few years, it may make sense to use the bulk of your Isa allowance for investments. However, it’s always prudent to keep some of your savings in cash for an emergency, such as a broken boiler or losing your job, and that’s where a cash Isa can still come in useful. The key is to get the best rate you can.

One trick to consider is whether it’s worth locking your money away for a few years to get a higher rate, even if you may want to take your money out early. The Isa rules mean providers must give you access to your money if you want, so fixed-rate cash Isas are more flexible than most fixed-rate savings accounts, which only let you withdraw cash in limited circumstances.

They can charge an early access penalty, but in some cases it’s sufficiently low as to make a longer-term fixed rate attractive even if you make an early withdrawal. It’s also worth looking for any loyalty deals or special offers that the “best buy” tables miss out (eg, small building societies may have good branch-based accounts for those who live in the area). It’s also important to monitor the best rates and be ready to transfer to a different provider if you’re getting a poor deal.