Savings are exciting again as gone are the days of paltry returns, so with plenty of high-paying accounts it’s important to make sure you’re making the most of good market conditions, which includes whether to choose between a cash ISA and a standard savings account.
I have been covering the savings market for more than 15 years, and it was right at the start of my stint in this industry that you could earn anything like what you can today, whether on a standard account or a tax-free cash ISA.
During the period of low rates following the global financial crisis, many stayed away from ISAs their rates were often dwarfed by standard savings rates, particularly since the introduction of the personal savings allowance in 2016 when millions no longer had to pay interest on savings, which diminished the gain of ISAs for many.
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Cash ISAs vs standard savings: what’s the difference?
Cash ISAs are just normal savings accounts that work in almost the same way, just that the interest isn’t taxed.
While many people don’t pay tax on standard savings accounts (see more on this, below), the benefit of a cash ISA is the interest is tax-free for life, unless the Government changes the rules. Even if you don’t pay tax now you may do in the near future if you have more to put away or rates keep rising.
After all, on a 5% interest rate, the cusp at which basic rate taxpayers (who pay 20% tax) start to pay tax is when they have more than £20,000 to save – which is a lot less than it was just a couple of years ago. For a higher rate payer (40%) it’s £10,000, while top rate taxpayers (45%) pay tax on all savings interest.
Why cash ISAs may be a better bet for many
As I write this, the top-paying easy-access cash ISA pays 5.08% compared to the top-paying standard easy-access account that pays 5.25%, which is hardly much of a difference. For every £1,000 you have, you’d get £1.70 more in interest a year on the standard account (before tax) which in my view is hardly anything for the peace of mind of your interest being tax-free for life in a cash ISA.
Do note that easy-access accounts, where you can withdraw money pretty much whenever you want, typically come with variable rates which means the returns can go up or down.
If you want a fixed rate, where the rate is, er, fixed for the term, then on a one-year fix, the top paying cash ISA pays 5.7% compared to 6% on a standard 1-year fixed savings account, at the time of writing. On £10,000, the gain from a standard account is only £3 per year before tax.
Yet note the "before tax" comment above. The gains in the above calculations assume you don’t pay tax. If you do, then a cash ISA blows a standard account out of the water. In the easy-access example above, a higher-rate taxpayer is better off by £19.60 a year for every £1,000 they have saved.
So if you are a saver, the case for ISAs is compelling whether you pay tax or not.
How standard savings are taxed
Under the personal savings allowance, basic taxpayers can earn £500 a year in interest before paying tax, while higher rate payers can earn £1,000 before being taxed. Top-rate taxpayers don’t get a personal savings allowance so pay tax on everything.
Needless to say, if you pay tax on savings then cash ISAs are a clear winner if you have enough of your ISA allowance left and want to save the money rather than invest it. Even if you don’t pay tax, if you think there’s even the slightest chance you may do so in the future I’d be giving up the small gains from a standard account for the peace of mind of having an ISA.
How much can you put in a cash ISA?
One point that could influence your decision is that you are limited to putting in £20,000 per tax year in an ISA – whether it’s a cash ISA, a stocks and shares ISA, or a P2P ISA. You can have a mix of types, as long as the combined maximum you deposit is £20,000 in all per tax year.
So, say, you have reached your limit and/or you want to use the limit for investments, then you may plump for a standard savings account.
Note that if you transfer an old ISA then however much of that goes into a new account, it does not count towards your £20,000 annual allowance, as that allowance is only for "new" ISA money.
What's the difference between cash ISAs and standard savings?
As well as a limit on what you can put in an ISA each tax year, the way cash ISA transfers work also makes them different from standard savings accounts. With a standard account, you can pay in money however you want – subject to what that provider allows (for example, you can’t pay in cash to an account that doesn’t have branch or Post Office access).
If you're transferring to a different ISA provider, you have to make an official transfer for that portion of cash to retain its tax-free status as an ISA and not contribute to your allowance for the current year (unless, of course, you first paid it in since 6 April). That means asking the new ISA provider to instigate the transfer which in itself provides you with peace of mind, that you don’t need to tell your bank where to send the money (for fear of getting the wrong sort code or account number). Instead, you’re letting the new bank identify where to take the money from. If you’re anything like me, you’ll know the anxiety from being responsible for typing in the right details (though these days many banks, but not all, warn you in advance if the name on the account where the money is going doesn’t match the name you enter).
Another difference is that with fixed-interest rate products, most savings providers don’t let you access the money for that term – for one year if it’s a one-year fixed rate, for example. But if it’s an ISA you can access your money if you need it, though you are likely to be charged a significant penalty, often of 2-6 months’ interest.
Earn less than 4%? Switch right away
Millions of people will be languishing on sub-2% accounts, particularly with the big banks, which in this higher interest rate environment is paltry. If you’re earning anything less than 5% you can almost certainly get a better rate, so my main message to anyone in this boat is to wave goodbye to a poor-paying account and move your money to somewhere that will allow it to grow at a decent rate.
For context, moving £10,000 from a 2% to a 5% account can earn you £300 more in interest per year before tax, which isn’t to be sniffed at.
While anything below 5% is beatable in most cases, I get that not everyone is determined to be on the best rate and won’t take the time (albeit what can sometimes be just 5-10 minutes) to switch for a few percentage points more.
Even if that’s you, I’d still urge you to take action if you’re on less than 4% as an extra £100 a year, if you move to 5%, is worth it in my view. I mean, £100 for potentially five minutes’ work is a very good hourly rate in my book.
Guy has extensive experience in personal finance journalism having joined The Money Edit after 13 years at MoneySavingExpert.com, most recently as deputy editor, and working closely alongside Martin Lewis.
He has also worked at the Daily Mail as a personal finance reporter and his work has appeared in The Sun, Guardian, Observer, Mirror and other national newspapers.
As a money and consumer expert, Guy is a regular guest on TV and radio – appearing on BBC News, BBC Radio 4, Sky News, ITV News and more.
Guy also often speaks at events and appears on personal finance discussion panels. He has also been a judge for numerous industry awards.
When he is not working on helping the public save money, he thinks he's a good bargain-hunter, whether by haggling on his broadband bill or spending hours researching the cheapest hotels for family holidays. But he's less good with his money when it comes to football, witnessed by the £1,400 he shells out each year on his Arsenal season ticket.
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