Why you should consider abandoning your cash Isa

Standard savings accounts are paying better rates than their tax-free cash Isa counterparts, says Ruth Jackson-Kirby.

Flowerpots with investment labels
Isas are good for investments but their advantage for cash has shrunk
(Image credit: © Getty Images)

Individual savings accounts (Isas) might seem like an obvious place to store your savings. However, interest rates on these accounts lag far behind standard savings products. Banks are paying as much as six times more interest on their standard savings accounts than their tax-free Isa equivalents, according to financial-comparison service Moneyfacts. The top rate for a one-year fixed-rate account is 2.4%, compared with 1.86% for the equivalent Isa.

Moneyfacts found that 57% of one-year fixed rate cash Isas pay less than the same non-Isa accounts, and a further 34% paid the same rate. Only 9% paid higher rates on Isas.

“It is a clear indication of how the personal savings allowance introduced in 2016 has killed off competition in the cash Isa market as more people opt for higher-paying non-tax free accounts,” says Ali Hussain in The Sunday Times.

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The personal savings allowance (PSA) allows basic-rate taxpayers to earn up to £1,000 interest on their savings before paying income tax on the returns. Higher-rate taxpayers get a £500 allowance, but additional-rate taxpayers get no personal savings allowance.

This means a basic-rate taxpayer can save up to £40,000 in the best buy one-year fixed rate bond from Al Rayan Bank paying 2.4% and they wouldn’t pay any tax on the £970 annual return. That means you can stash double the current Isa allowance tax-free.

A higher rate taxpayer could pay their full Isa allowance of £20,000 into Al Rayan’s non-Isa account with a return of £475 that skims just under their £500 PSA. Contrastingly, Al Rayan Bank’s one-year, fixed-rate cash Isa pays just 0.4%, meaning someone putting the full £20,000 Isa allowance into this account would earn just £80 interest.

Don’t rule Isas out entirely

It is hardly surprising, then, that cash Isas have been falling out of favour. Savings in the tax-free accounts hit a peak of £295bn in January 2021 but had fallen to £287bn by April of this year.

That’s not to say you should leave Isas out of your savings plan. The problem with the PSA is it can change. If you get a pay rise, your personal savings allowance could halve, or even disappear, overnight. Depending on how much you have in cash savings this could mean a sudden tax bill that could have been avoided if your savings were in an Isa.

The other issue is that if interest rates rise you could find yourself exceeding your PSA and paying tax on the excess.

The benefit of Isas is you know your cash is shielded from tax no matter what you earn, or how big your savings grow – but as interest rates stand, putting long-term savings into a stocks and shares Isa might be more fruitful.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings and credit cards to pensions, property and pet insurance. 

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping among many other titles both online and offline.