Ever since the Bank of England cut rates to 0.5% in March 2009, savers have had to bear the brunt of the Bank of England’s monetary policy. But last March, George Osborne threw them a bone by announcing that the first £1,000 of interest income on savings would be tax-free. Even on the best rates currently available, you’d need to lock up almost £50,000 for two years before you’d exceed this. So given that cash Isas currently have an annual contribution limit of £15,240 and the tax advantage they have over regular savings accounts will be eliminated for many, you might wonder whether you should give them a miss.
However, cash Isas still have an important role. First, wealthier savers will not be entitled to the full £1,000 personal savings allowance: higher-rate taxpayers get a smaller allowance of £500, while those paying 45% on earnings don’t get anything. So it makes more sense for higher-rate taxpayers – or those who may be higher-rate taxpayers in the future – to keep using Isas.
Second, even if you are able to get the full tax-free interest allowance, it will become less attractive once interest rates rise. This is because the amount you will be able to save without having to pay tax on the interest will fall (if the best savings rates go back to 4%, the maximum will fall to £25,000 for basic-rate taxpayers and just £12,500 for higher-rate taxpayers). While plunging global stockmarkets and concerns about deflation mean that interest-rate hikes may seem a long way off, things could change quickly – especially if energy and commodity price declines reverse themselves, pushing up inflation.
Third, you should remember that any money put into Isas in previous tax years will continue to earn interest tax-free and that you can transfer previous years’ Isas around to get the best interest rates. So if you’re a high earner and determined saver contributing the maximum each year, you could relatively easily accumulate £75,000 in tax-free savings after only a few years. In addition, Isas now come with some inheritance tax benefits: while the money in the Isa is not exempt from the tax, your spouse will be able to inherit the account with the tax-free status, so they won’t have to pay tax on any subsequent interest.
Of course, you can never rule out the possibility of a revenue-hungry government changing the rules by introducing a limit on the total size of cumulative Isa pots, or restricting the ability of high earners to put money into them. However, the £1,000 interest allowance isn’t any more secure. Indeed, you could argue that since it’s intended to compensate for low interest rates, it loses its purpose once interest rates gradually start to return to historic levels. It’s also important to point out that the government clearly wants people to put more in Isas, so any changes that make putting money into Isas less attractive would undermine this.
Finally, Isas tend to be a much better choice if you want a fixed-rate deal. While there are fixed-rate savings accounts available, they offer little or no flexibility, normally preventing any access to the money held during the period. However, while Isa providers are allowed to prevent partial withdrawals, the Isa regulations mean that they have to let people close down the account at any time (although they can impose interest-rate penalties for doing so). This means that, in an emergency, fixed-rate Isas can effectively function in a similar way to easy-access accounts, but with a better rate of interest.
|Five of the best cash Isas|
|State Bank of India Online Isa Fixed Deposit||Fixed for five years||£15,000||2.6%||No interest paid if closed within one year and 1.6% interest paid if closed after one year, but before five years. Allows transfers in.|
|Coventry Building Society Fixed Rate Isa||Fixed until 31 May 2018||£1||1.70%||Early account closures subject to 120 day interest penalty. Allows transfers in.|
|Virgin Money 1 year Fixed Rate Cash E-Isa UK.||Fixed until 24 Feb 2017||£1||1.50%||Withdrawals subject to 60 days’ interest penalty on amount withdrawn. Allows transfers in.|
|Post Office Online Isa||Variable||£100||1.45%||Unlimited withdrawals. Rate includes a 0.8% bonus for first year. Also allows you to split your contribution with a fixed Isa (1.55% fixed for two years). Allows transfers in.|
|Coventry Building Society Easy Access Isa||Variable||£1||1.40%||Unlimited withdrawals. Does not allow transfers in.|