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

Cash ISAs and savings accounts do effectively the same thing, growing your money at a set rate of interest, but they differ on one vital point.

As Individual Savings Accounts (ISAs) are tax-wrappers, any interest you earn from money in a cash ISA isn’t taxed, no matter how high the interest rate is.

For example, if you held £100,000 in a top cash ISA paying 4.5% interest, you would not pay a penny of tax on the £4,500 interest you would earn over the year.

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This is not the case for savings accounts. Any interest earned from money held in a non-ISA savings account can be taxed. There are some tax-free allowances though – such as the personal savings allowance (PSA).

While tax-free interest can be incredibly useful, ISAs have an annual limit and tend to offer lower interest rates, meaning there are times when a savings account could be a better home for your cash.

How savings are taxed

In the UK, savings interest above your tax-free allowance is taxed at the same rate as your income tax band.

No tax is deducted from the first £12,570 you earn, even if this comes from savings interest.

Savings interest above tax-free allowances is taxed at 20% for basic rate taxpayers with an income between £12,571 and £50,270, 40% for higher rate payers with incomes between £50,271 and £125,140, and 45% for additional rate payers with an income above £125,140.

From April 2027, the tax rates on savings income will rise by two percentage points.

Tax-free allowances for savers

The personal savings allowance (PSA) allows most taxpayers to earn interest from their savings without having to pay tax on it.

Basic rate taxpayers can earn up to £1,000 in savings interest from non-ISA accounts without paying tax. Interest earned above this is taxed at 20%.

The PSA is reduced to £500 for higher rate taxpayers, with interest earned above this threshold being taxed at 40%.

Additional rate taxpayers do not receive a personal savings allowance, so all their savings interest from non-ISA accounts is taxed at 45%.

Savings interest can tip you into another tax band, reducing or removing your personal savings allowance.

Some people with low incomes can also earn up to £5,000 of interest tax-free through the starting rate for savings.

This allowance reduces by £1 for every £1 of other income you receive above the £12,570 personal allowance. People with an income of £17,570 or more will not be able to get this allowance.

How do cash ISAs work?

Any money you hold in a cash ISA can earn interest without being taxed, no matter how much you earn.

This is because all types of ISAs – cash ISAs, stocks and shares ISAs, junior ISAs, and others – protect the money held in them from all tax.

But you can only put a maximum of £20,000 into ISAs each tax year and any unused ISA allowance cannot be carried over to future years.

From April 2027, the maximum you can put into a cash ISA will fall to £12,000 for under 65s.

To use your entire £20,000 limit in the 2027/28 tax year onwards, you will need to put the remaining £8,000 into another type, such as a stocks and shares ISA, if you put the first £12,000 into cash ISAs.

Cash ISA vs traditional savings accounts: Which one is right for me?

When deciding whether a cash ISA or a traditional savings account is right for you, consider what the interest rates are, and how the interest earned could be taxed.

As a rule of thumb, it tends to be a good idea to put your savings into the account with the highest interest rate from an FSCS-protected provider. This means your money is working as hard as it can for you, and means it does not fall behind inflation.

Broadly speaking, traditional savings accounts tend to pay higher interest rates than cash ISAs, but as shown above, you run the risk of having to pay tax on your interest payments.

That means you should weigh up how much interest you expect to earn in a year and the amount of tax you will pay on it.

If your tax-free allowances mean you won’t pay any tax on your interest payments, then you should make the most of the top rate as you will not have to worry about tax.

However, if you do expect to pay tax on your savings interest, then you may consider putting some or all of the money into a cash ISA instead, even if it pays a slightly lower interest rate than the traditional savings account.

Doing this will protect your interest payments from the taxman.

This will be particularly important for higher earners who can earn very little interest on their savings before it starts being taxed.

For example, an additional rate taxpayer with £10,000 in a non-ISA savings account paying 4.5% would earn £450 in interest over a year.

Because they do not have a personal savings allowance, the taxman will be entitled to 45% of it. If this money was held in an ISA, no tax would need to be paid.

Jessica Sheldon, deputy digital editor at MoneyWeek, said: “Frozen tax thresholds and allowances and the upcoming tax hike on savings income mean it’s all the more important to check whether you’d be better off putting your cash in an ISA.

“Not doing so could mean you pay more tax than you need to.”