During the years of rock-bottom interest rates, there seemed very little point in using cash Isas if you were looking for a meaningful return on your savings. Over the past year or so, however, these savings vehicles have been enjoying a resurgence in popularity, as interest rates have climbed and remain elevated.
Even when inflation started to bite and rates began to rise in early 2022, cash Isas were still being overlooked; instead, savers’ attention was focused on the fierce battle over rates between providers of fixed-rate bonds.
Anna Bowes, founder of the Savings Champion website, says: “The gap between the top-paying bonds and equivalent Isas had increased to more than 40 per cent — far more than the tax benefit of putting money into an Isa.”
In August 2021 the top one-year bond was paying 1.38 per cent before tax, 1.1 per cent if basic rate tax was deducted and 0.83 per cent after higher rate 40 per cent tax. The top Isa, on the other hand, was paying just 0.8 per cent — less even than a higher-rate taxpayer would have earned on the bond.
Rising interest rates have changed that dynamic, drawing more people back into these tax-sheltered vehicles by boosting competition between providers and closing the gap between bond and Isa rates.
“Today, the top one-year fixed rate bond is paying 5.28 per cent, but the top Isas pay more than 5 per cent. So anyone paying tax on their savings would earn more by putting their money into the Isa,” says Bowes.
As tax-free allowances have been frozen or cut, there is much more incentive for taxpayers to make use of all their tax allowances, especially their cash Isa. That’s particularly so given the increasing numbers being drawn into taxpaying status.
Research by the campaign group TaxPayers’ Alliance has found that there are now 35.5mn people paying income tax, compared with 31mn in 2010. Most of that extra 4.5mn have become taxpayers over the past three years through recent tax threshold freezes.
“The plethora of stealth taxes, including the ongoing freeze to our personal allowances, means 2.5mn have become taxpayers since these taxes came into force in 2021 — and more than a million people have been dragged into the higher rate tax bracket,” Bowes observes.
Particularly significant for savers has been the freezing of the personal savings allowance (PSA), which has remained unchanged since its introduction in April 2016, providing £1,000 of tax-free interest for basic-rate taxpayers and £500 for higher-rate ones.
At that time, the top-paying easy access account was paying 1.45 per cent, meaning a saver would need capital worth £69,000 to receive more than £1,000 of gross interest.
Today, the top easy access account pays 5.11 per cent, so a deposit of just £19,570 — less than the £20,000 annual Isa allowance — will earn more than £1,000 and breach the PSA. For someone paying higher rate tax and therefore with only £500 of PSA, savings of less than £10,000 will push them into taxable territory.
During the era of low interest rates and bullish stock markets, it made sense to use the Isa allowance to shelter equities in preference to cash because they were likely to grow so much more over the longer term. That arguably still holds true. Nonetheless, says Justin Modray, founder of Candid Financial Advice, cash tax shelters are much more valuable than they were.
“If you don’t plan to use your full Isa allowance investing via a shares Isa, then moving savings into a cash Isa makes sense,” he comments. “Even though you may already enjoy tax-free savings via the PSA, accumulating savings within an Isa could prove valuable over time.”
The stealth effect on cash savings income continues: neither the stagnant PSA nor the cash Isa allowance of up to £20,000 was touched in the recent Budget. Instead, a planned British Isa allowance of up to £5,000 for investments in British companies is set to provide a boost for equity investors.
However, there are some broader changes to the annual tax-free savings subscription that will take effect from the start of the new tax year and are worth knowing about. In particular, from April it will be possible to invest in multiple Isas in a single tax year.
For cash savers keen on fixed-term Isa accounts this is a good thing, says Bowes. “If you had funded a fixed-term Isa (which usually have limited funding periods) with less than the full allowance, and then wanted to top up at a later date, you would usually have needed to open another Isa to do so, which in the majority of cases is not allowed.” The new rules will make that possible.
For savers looking for a home for their money before April, the biggest questions are likely to be about timescale: how long before rates start to fall again? How long should I tie my money up for? Of course, that depends to some extent on what you want to do with it, and when. But for spare cash these are valid questions.
Unusually, longer term rates are lower than shorter term rates at the moment, and fixed-rate deals — usually the more generous payers — are paying less than variable. Bowes says: “This is a clear indication that the markets are expecting base rate cuts and therefore more cuts to the best savings rates, so it might be a good idea to tie at least some of your cash up for the longer term if you don’t need it.”
Modray agrees: “If you can tie up cash and want certainty, a fixed rate can still be a sensible option,” he suggests.
Current cash Isa best buys include the Virgin Money Defined Access cash E-Isa Issue 25 paying 5.06 per cent, and the Moneybox Cash Isa paying 5.11 per cent. Savers are limited to three annual withdrawals a year for both products. Meanwhile, Aldermore pays 4.5 per cent fixed for three years.
Source: Economy - ft.com
