The popularity of cash Isas has declined over the past few years thanks to low interest rates and the arrival of the personal savings allowance (PSA) in 2016. Nonetheless, these tax safe havens should still form a part of any sensible savings plan.
The PSA means that basic-rate taxpayers can earn up to £1,000 interest a year on their savings before tax becomes payable. This falls to £500 a year for higher-rate taxpayers; there is no allowance for additional-rate taxpayers. Add in the fact that non-Isa savings accounts tend to have higher interest rates and you can see see why Isas have fallen out of favour.
In order to grasp the benefit of cash Isas you need to take a long-term view. At present we are living in a low-interest rate environment, which means that you would need to save a considerable sum to risk exceeding the PSA. Assuming an interest rate of 1.5% the best easy-access rate available a basic-rate taxpayer would need £70,000 in savings to earn more than £1,000 interest.
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But if interest rates were to rise to say, 5% where they were 11 years ago, then that £70,000 nest egg would earn £3,500 interest in a year. Any interest you earn over the allowance is taxed as income so a basic-rate taxpayer would have to hand 20% to HMRC. Even a savings fund worth £20,000 would nearly exceed the allowance, as it would earn £1,000 of interest in a year.
Don't rely on the personal savings allowance
Another problem with the tax-free allowance isthat it could decline overnight if you get a pay rise.If your income climbs and you move into a highertax bracket, your allowance plummets. It falls to£500 a year if you become a higher-rate taxpayerand to zero if your income exceeds £150,000 ayear, making you an additional-rate taxpayer.
So you could find yourself suddenly paying income tax on your savings. By contrast, a cash Isa is tax-free regardless of how much you earn or how big your balance grows.
When it comes to interest rates, cash Isas have tended to lag behind traditional accounts. Fortunately, that is no longer the case across the board. The best instant-access cash Isa rate is 1.5%, the same as on standard accounts. On fixed-rate bonds the interest rate is slightly lower, but the situation is improving. The average one-year cash Isa rate hit its highest level for three years in January at 1.35%, according to data from Moneyfacts.
With cash Isas, as with any financial product, it's important to check often that you are getting the best deal. The final weeks of the tax year provide a good opportunity to take a look at your Isas and see if you could get a better interest rate by transferring to a different provider. Transferring an Isa is a simple process, but you have to follow the rules otherwise your money could lose its tax-free status and count towards your current Isa allowance again. The key is not to withdraw your money and pay it into a new Isa. You need to follow the official Isa transfer process.
You just choose the Isa account you want to move to and inform that provider of the details of your old Isa. They will then arrange for the money to be moved into the new account. If you are checking your existing Isa rates, then presuming you are free to move the money and it isn't locked into a fixed-rate account (always check the withdrawal rules), you should be looking to transfer if you are earning less than 1.5%.
The best current rate for an instant-access cash Isa is 1.5% from Coventry Building Society. There is no minimum balance and it accepts transfers from other Isas. Just be aware that the account has a 0.35% bonus that ends in July 2020. You have to open it online, but then you can manage it by post or in-branch as well as on the web.
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