ISAs vs savings accounts: what’s the best home for your cash savings?

An ongoing freeze to tax allowances is putting savers at greater risk of being taxed on their savings, particularly amid a stronger interest rate environment.

Almost 2.1 million people are expected to pay tax on their savings this year, including 954,000 basic-rate taxpayers and 590,000 higher-rate taxpayers, a Freedom of Information request from AJ Bell showed.

It means around one in 30 basic-rate taxpayers are set to pay tax on their savings this year, up from less than one in 100 three years ago.

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Nearly one in 10 higher-rate taxpayers are expected to pay the tax now, compared to around one in 25 just three years ago.

Why are more savers facing tax on savings interest?

Savings accounts have become much more attractive recently, following 14 consecutive Bank of England base rate hikes and lower levels of inflation. The higher interest rates, combined with frozen tax allowances, leaves more and more savers at risk of being taxed.

Cash ISAs are a tax-free savings vehicle, meaning they are a useful way to protect interest on savings from the taxman.

These tax-free wrappers had fallen out of favour in recent years as paltry interest rates across all types of accounts meant many savers found themselves well within the personal savings allowance threshold.

Laura Suter, director of personal finance at AJ Bell, told MoneyWeek: “Previously the majority of people didn’t need to worry about paying tax on their savings, as interest rates were low and the personal savings allowance was sufficient to cover most people.

“But now a tricky combination of interest rates rising, cash ISAs being shunned for decades, more people moving into higher tax brackets and seeing their personal savings allowance cut, and the tax-free allowance being frozen means lots of people are being dragged into the tax.”

Cash ISA vs traditional savings accounts: Which pays more?

The interest rates offered on the best savings accounts are substantially higher than the rates seen two years ago, with the top rate for a one-year fixed savings account currently standing at 4.77% AER/gross. The highest-paying easy access account (including bonus) pays 5% AER/4.89% gross. Rates are according to Moneyfactscompare.co.uk and correct at the time of writing.

The best cash ISA rates are also competitive compared to other savings accounts at the moment - the highest-paying one-year fixed ISA offers a rate of 4.55% AER while the top variable cash ISA currently pays 5.1% AER.

The number of savings accounts (excluding cash ISAs) stood at 1,542 at the start of 2025, while the number of cash ISAs on the market was 574, according to Moneyfactscompare.co.uk.

We look at what savers need to consider when deciding between a traditional savings account and an ISA.

Why choose a traditional savings account?

Savers making use of cash savings accounts have benefited from the combination of low-interest rates and the personal savings allowance in the past.

Interest earned on savings is not tax-free, although there are allowances available.

Tax on savings

Taxpayers can use their personal allowance (typically £12,570) to earn interest tax-free if it hasn't been used up on other forms of income, such as wages or pension.

Some people can also earn up to £5,000 of interest tax-free, known as the starting rate for savings. This allowance reduces by £1 for every £1 of other income above the personal allowance. People with income of £17,570 or more will not be able to get this allowance.

The personal savings allowance protects some savings interest from the taxman.

Basic rate taxpayers can earn £1,000 in interest tax-free via this allowance, while higher rate taxpayers have a personal savings allowance of £500. Additional rate taxpayers are not eligible for any personal savings allowance, meaning every penny they earn in interest is taxable.

Given the low-interest rates paid by savings accounts of all kinds in recent years, many savers may have not earned enough in interest to trouble the taxman.

What’s more, the rates on the best savings accounts have typically been noticeably higher than those paid by tax-free ISAs.

That’s not currently the case - the top regular easy access account today pays a rate of 5% AER/4.89% gross while the top variable cash ISA pays currently pays slightly more than 5%.

Unlike ISAs, traditional savings accounts do not tend to have a cap on how much you can save in them.

You can usually put in as much as you like within the account, though it’s worth bearing in mind that the Financial Services Compensation Scheme only protects the first £85,000 saved in each financial institution in the event that it goes bust.

The case against traditional savings accounts

Once you start to build a larger savings pot ‒ particularly if you are a higher-rate taxpayer ‒ you’re far more likely to have to hand over some of the earnings to the taxman, particularly as savings rates rise.

AJ Bell has calculated that higher-rate taxpayers will start paying income tax on their interest once they have £10,000 in the current top easy access account, which pays 5%.

Basic rate taxpayers could save up to £20,000 in an account with this rate before their savings are subject to tax.

With interest rates expected to fall this year, some savers will be looking to lock up their money for a longer period, in order to secure current savings deals.

Higher-rate taxpayers who took out a one-year fixed rate account paying 4.77% could hold a total of £10,500 in savings at this rate, before being subject to tax.

Basic rate taxpayers could hold £21,000 tax-free, if all of their savings were fixed in an account paying the 4.77% rate.

If interest rates were to rise, more savers with traditional savings accounts would find their returns are taxed as they would earn above the personal savings allowance.

“Often savers won’t realise they owe tax on their cash savings until a brown letter lands on their doormat,” Laura Suter, from AJ Bell, warned.

“Those filling out a self-assessment tax return will declare any savings interest, and subsequent tax due.

“But, for those taxed under PAYE, HMRC will calculate any tax due based on information sent to them by banks and building societies.”

Why choose an ISA?

ISAs allow savers to enjoy the full fruits of their saving efforts, entirely tax-free.

As a result, if you have a significant savings pot then an ISA is bound to appeal, although there is an annual ISA allowance ‒ currently set at £20,000 for the 2024/25 financial year.

There are various types of ISA available, but the annual ISA allowance spans deposits into all of these options per tax year.

Cash ISAs

If you’re a saver who wants some low-risk certainty then you can put your money into a Cash ISA, which works exactly like a traditional savings account except that the returns are guaranteed to be tax-free.

Stocks and shares ISAs

If you’re happy to accept a little more risk, in return for the chance of higher returns, then you could opt for a stocks and shares ISA.

The types of investment that can be held within a stocks and shares ISA varies based on the provider, but it allows savers to enjoy every penny of the returns generated from individual stocks, funds, bonds and the like in their ISA.

Lifetime ISAs

The Lifetime ISA (LISA) is another type of ISA, which is aimed at two distinct types of saver: those looking to build up a deposit to use when purchasing a house, or those who want to save for retirement.

Eligible savers can deposit up to £4,000 per tax year into a LISA - this limit counts towards the £20,000 annual ISA allowance.

The money you save in a Lifetime ISA is eligible for a 25% bonus from the government each year, with the bonus capped at £1,000. You must be under 40 to open a Lifetime Isa and if you’re using a Lifetime Isa to save for retirement you won’t be able to access the cash until age 60 without incurring a penalty.

Innovative finance ISAs

Another form of investment ISA available is the Innovative Finance Isa, which can be used to invest in alternative assets like peer-to-peer loans.

Junior ISAs

A Junior ISA (JISA) is a tax-free savings account specifically for children.

Parents can put money aside for their children in a Junior ISA, but the money belongs to the child. The child can take control of the account when they turn 16 but can’t withdraw from it until their 18th birthday.

There is a different limit for Junior ISAs - up to £9,000 can be deposited in Junior ISAs per tax year.

There are two types: a cash Junior ISA and a stocks and shares Junior ISA. A child can have one or both of these types.

How much can you put in a cash ISA?

You can deposit up to £20,000 into ISAs each tax year, but you can also transfer ISA savings. Savers could benefit from moving ISA savings from previous years to accounts that allow transfers as rates rise, while preserving the tax-free status.

Any unused ISA allowance cannot be carried over to future years. So, if you save less than £20,000 in any tax year, that unused allowance is gone forever. This could be frustrating if you suddenly come into a windfall – for example, a large bonus or an inheritance.

Previously, you could only open one of each main type of ISA in any one tax year, but this rule changed as of April 6, 2024.

Now, savers can open and pay into multiple of the same type of ISA, for example open more than one cash ISA, within a tax year.

Rachel Springall, finance expert at Moneyfactscompare.co.uk, told MoneyWeek: “Cash ISAs overall have a key part to play this year for savers looking to protect their investment from tax. This is even more pressing for those who may breach their personal savings allowance (PSA) and start paying tax on the interest they earn beyond the set thresholds.”

Providers will likely make efforts to entice savers with newly priced fixed rate ISAs in early 2025, Springall said, but the “peak of such a rate war” would typically be seen in March and early April at the start of the new tax year.

“Therefore, some savers may feel inclined to adopt a wait and see approach until nearer the new tax-year,” she said.

“However, some savings deals outside of an ISA wrapper can pay better rates and it is worth noting that not every savings provider offers a Cash ISA.

“Whichever type of account consumers choose this year, providers need to work hard to tailor their range to suit unique needs and serve their savers well.”

The case against ISAs

While the returns from ISAs are free of tax, that doesn’t necessarily mean that you will be better off by using them. If you opt for an investment ISA (the stocks and shares ISA or the innovative finance ISA), there is the risk that the assets you invest in could lose value. As a result, you may end up with less than you started with.

Moving money between ISAs can also be challenging. Not all ISAs accept inward transfers. This means that you cannot move money that’s already held in an Isa into them. This can mean limited choice when it comes to finding a new home for your savings. What’s more, the money must be transferred directly from one ISA to another, in order to retain its tax-free status.

If you withdraw the savings from an ISA, even if it’s to subsequently deposit it into another ISA, it will count towards the £20,000 annual ISA allowance. ISA transfers do not count.

Making the most of both traditional savings accounts and ISAs

There is nothing to stop savers from using both ISAs and regular savings accounts. In fact, for some savers, this will make sense.

For example, if you have used the entirety of your £20,000 annual ISA allowance, then that does not have to be the limit to your savings. Once you hit that threshold you can continue to save money in a traditional savings account for the rest of the tax year.

It also might make sense to divide the money you’re saving ‒ based on whether you need to access it in the short or long term, and the interest rates available on different accounts.