Should I consider saving in a Cash ISA (Individual Savings Account)?

09/03/2018

So, let’s look a bit closer at them this month and see whether they should be something you consider for your savings.

Background

ISAs were introduced in 1999 as a replacement for PEPs (which were used for shares) and TESSAs (which were used for cash savings). Initially the overall allowance was £7,000 with a maximum of £3,000 being allowed for cash. For nine years, this remained the case until we saw a £600 increase in the cash allowance in 2008.

2011 saw the introduction of the Junior ISA for children and in 2014 we saw a huge increase in the ISA allowance with £15,000 being permitted within an ISA and it being possible to hold the entire amount in cash. Last year, this increased to £20,000 and the allowance will be maintained at this amount for 2018/19 tax year which starts on 6^th April.

What is the difference between Cash ISAs and ordinary savings accounts?

Fundamentally, there’s very little differences in the actual account itself. A cash ISA is not dissimilar to an ordinary savings account, it’s just got a tax wrapper around it which means you aren’t liable to pay tax on the interest you earn. Think of it like a two chocolate bars, one still in the wrapper and one out of it – they are the same chocolate bar. 

The main difference is the interest rates charged on the different accounts. In the early days of ISAs, there were some very competitive rates as providers fought for your cash ISA savings. In 2018, it is a very different situation with ordinary savings accounts often paying more than their cash ISA equivalents – sometimes considerably more.

For example, the best one year fixed rate is 1.95% whereas the best one year ISA pays just 1.46%. Similarly, on a five-year fixed 2.52% can be found on a standard account whereas the best five year ISA is 2.25% by comparison.

Personal Savings Allowance

In 2016, the government introduced a Personal Savings Allowance which means that basic rate tax payers can earn £1,000 in savings interest before needing to pay tax and higher rate tax payers can earn £500 before paying tax. As a result, banks pay interest without any tax deduced now whereas previously you had to fill in a special form for this to be done or tax would automatically be deducted.

This means a basic rate tax payer could have £75,000 in the top paying instant savings account (1.30% from RCI Bank) and not pay any tax on the interest.

So, are cash ISAs pointless now?

Well, not exactly. For many people, there will be little or no immediate financial benefit to open a Cash ISA instead of a traditional savings account. However, there are exceptions and things to consider:

1. Savings in a Cash ISA stay tax free year after year 

Anyone who has opened an ISA every tax year since 1999, and used the full allowance, has been able to shelter over £121,500 plus interest from the tax man and, in April, will be able to add another £20,000 to that allowance.

2.  You can now switch your cash ISA in to a stocks and shares ISA

Until recently this wasn’t something you could do but some people will like the flexibility this allows and may want to hold cash for a period before investing.

3. The Personal Savings Allowance (PSA) could change

There is no guarantee the PSA will be continue and the allowance could be cut or removed. Additional rate tax payers get no allowance. Also, if interest rates rise, the value of the PSA will diminish too as smaller balances will then earn more interest and use the allowance up.

4. There will be accounts worth considering

Nationwide have just launched a cash ISA with no notice required paying 1.30%, which is the same as the best standard paying account. Although only one withdrawal is allowed from the Nationwide account, whereas the non-ISA account from RCI Bank allows unlimited withdrawals, the Nationwide account may appeal to those who wish to secure their ISA allowance in cash for the year.

5. Junior ISAs

Junior ISAs come with their own allowance (£4,128 this year) and rates on them are very competitive. Coventry Building Society pay 3.50% and Nationwide pay 3.25% on instant access, which beat the best ordinary paying accounts for children with no restrictions.

6. Lifetime ISAs

Lifetime ISAs, also known as LISAs, come with a £4,000 allowance within your overall ISA allowance of £20,000. So, if you invest £4,000 in a LISA, you can only put £16,000 in a cash ISA or stocks and shares ISA. LISAs are available for those aged 18 – 40 and you get a 25% bonus from the government each year on top of anything you save. So, if you save £4,000 you get £1,000 from the government. The bonus is paid every year until you are 50 years old.

LISAs are aimed at first time buyers saving a deposit to purchase a home and for those looking to save for retirement. They have been somewhat controversial because there was already a scheme in place (Help to buy) for first time buyers and pensions provide generous tax relief for savers with many financial advisors still considering this a better form of retirement saving.

There was little consultation from the government before LISAs and, as a result, there is only one provider of a cash LISA, Skipton Building Society. Skipton pay 0.75% interest.   However, those saving for a home will find the 25% government bonus attractive and should certainly consider a LISA if they are saving for a deposit.

That’s all for March. Have a great month and see you in April!

James

Key Facts

ISA accounts

Nationwide Single Access - https://www.nationwide.co.uk/products/savings/single-access-isa/features-and-benefits

Coventry Building Society Junior ISA – https://www.coventrybuildingsociety.co.uk/consumer/product/savings/children/junior-cash-isa.html

Nationwide Junior ISA - https://www.nationwide.co.uk/products/savings/junior-isa/features-and-benefits

Skipton Lifetime ISA - https://www.skipton.co.uk/savings/isas/cash-lifetime-isa