Irrelevant Savings Accounts: Why Cash ISAs are dead

Why I don’t put my money in a Cash ISA.

When my friends talk to me about savings, they always mention ISAs. It’s where they’ve always been told to save their cash (though they don’t quite understand why), and they’ve dutifully stashed as much of their savings in one as they could. But I don’t have one. I haven’t had one for close to six years.

The whole point of an ISA (or Individual Savings Account) is that any interest you earn is tax-free. So if you had £5,000 earning 3%, you’d get to keep all of the £150 you’d make, rather than lose 20% or 40% to the taxman. So logically, a lower rate ISA could be better than a higher paying standard savings account.

But in reality for the last few years the legitimate tax loophole provided by an ISA has made sod all difference for most people.

In part it’s down to really poor interest rates. Before the crash in 2007, the average rate of interest for a Cash ISA was more than 5%. Nice! The best rate today for an easy access Cash ISA (where you can access your money whenever you want) is a pretty rubbish 1.45%. And that’s the highest it’s got for years.

But the main reason I haven’t had an ISA, and why you probably don’t need one either, is down to a rule change from a few years ago.

You can earn tax-free interest without an ISA

In April 2016 the Personal Savings Allowance (PSA) was introduced to give pretty much everyone tax-free interest on savings from any source, not just ISAs. In fact, any earnings in an ISA don’t count towards your PSA.

The PSA works like this. If you are a zero or basic rate taxpayer (essentially you earn under £46,351, or less than £50,001 from April 2019), you can make £1,000 in interest in a year before you start paying tax on it. That’s a huge amount.

If you earn a little more and pay 40% tax, then you still get an allowance, but it’s reduced to £500 a year.

So with a 1.5% easy access savings account (the best rate available in one at the moment), you’d get £7.50 interest tax-free for every £500 saved. To put it in perspective, that means you’ll need £33,333 before you hit £500 in interest, and £66,667 before you’d reach the full £1,000 PSA.

Better paying alternatives to Cash ISAs

So if you don’t need an ISA to earn tax-free interest, what should you be doing with your savings?

I wrote a few weeks ago about the highest paying cash savings options such as specific current accounts and regular saver accounts. It’s in these accounts that I put my money and I get an above-inflation average return – possibly up to a huge 5%. You can also look at app only accounts such as Chip. There’s more information on each of these in the same article.

If you do take advantage of these and have a decent amount of money saved you could approach the PSA limit faster – but it’s still unlikely to affect most basic rate taxpayers.

That’s because most of the accounts will have limits on how much you can earn interest on. Say you have £1,500 at TSB earning 5%, that’s £75. Putting £300 a month into First Direct’s Regular Saver will net you close to £100 after 12 months. Far better returns, but still some way of £1,000.

What if you earn more than the Personal Savings Allowance?

Of course you might earn more than the PSA if you have multiple high earning current accounts and regular savers – especially if your’s has been lowered to £500. Or you might just have a huge stack of cash. As I said earlier, £67,000 earning 1.5% will earn you more than £1,000 over 12 months.

So what then? Well, you’ll want to get a… Cash ISA. Okay, okay. I know I’ve just written 600 words saying don’t bother with Cash ISAs. 

Let’s say you’ve maxed out your PSA with that 1.5% account. Every extra £1 of interest you earn will now be taxed at 20% or 40%, bringing the real rate down to 1.2% or 0.9% respectively.

Now as long as you can beat that rate with an ISA – which you currently can – then the tax-free part of an ISA does make a difference, making an ISA the best home for your additional savings. Though bear in mind there’s an annual limit of £20,000 that can be paid in to an ISA each financial year.

And if you’re likely to have a fair bit of cash saved every year, another feature in favour of ISAs is that they keep earning tax-free interest year after year.  This could help in future years if interest rates were to rise or if the PSA was to shrink. Higher rates would mean the PSA tax-free limit would be reached sooner, especially if you’re a higher rate taxpayer, so having some cash in an ISA could boost tax-free returns.

Alternatives to cash savings and ISAs

The above is all focused on easy-access cash ISAs and savings accounts. But there are alternatives if you don’t mind locking money away or are happy to risk the money as an investment.

First, fixing. There are Cash ISAs and savings accounts where you can lock money away for multiple years. This means you can’t withdraw the money for the set duration unless you’re prepared to forfeit the interest earned or pay a penalty. But rates can be higher if you do

And if you’re willing to leave your money locked away for at least five years or more, then a Stocks and Shares ISA could be for you. The thing to remember is there’s also the risk you could lose some of your savings if your investments don’t work out well. Though if they do, the return could be much higher than elsewhere.

If you’re a first-time home buyer or self-employed then there is an ISA which could be good for you. I’ve written about the Lifetime ISA, or LISA, before, so take a look at that article for more information. But in essence, you’ll get a 25% bonus, to a maximum of £1,000 a year, towards either your first home or retirement. There are pros and cons, but free money is free money right? The Help-to-Buy ISA works in a similar way, but just for buying a home.

Of course, you don’t have to save all your money. Personally, I’d always try to keep an emergency buffer of cash savings, but if you have any debts, it makes sense to clear them first, particularly while interest rates are low. You might also be better off overpaying your mortgage (if you’re allowed to).

Want more? Check out these savings articles from the blog

The best savings accounts (May 2021)

The ISA that’ll give you a free £1,000 – but there’s a catch

4 thoughts on “Irrelevant Savings Accounts: Why Cash ISAs are dead

  1. If someone earns e.g. £5000 salary and 1200 interest on non-IFISA p2p investments in a year then does she pay 0 income tax because the total income is less than 12500, or does she pay 0% on 1000 of the interest, but 20% on the £200 interest that is above the threshold of £1000?
    Thanks a lot
    Janos

  2. ISAs were introduced in 1999 by Gordon Brown and subscription limits have always gone up.
    The Personal Savings Allowance was introduced in 2016 by George Osborne.
    Yes, ISA rates, especially compared to the PSA are derisory.
    Whether you make the most of the allowance or not should have a lot to do with what you’re saving for.
    If you’re actually saving for something specific (car, holiday of a lifetime, etc.) then you may be better off utilising the slightly higher paying fixed term accounts.
    I believe that cash ISAs should be part of a portfolio, where you’re just saving, like me for less stress later on.
    Time has yet to tell what will happen to the PSA rates or even if successive governments will keep it or ditch it.
    Right now, I trust in ISAs staying around for a lot longer and I’m prepared to live with the slightly lesser pitiful return.

  3. Hello, I have already paid my full £20,000 ISA allowance into a new Cash ISA account this tax year with TSB. Would it be possible to also set up a new Nationwide Cash ISA account this tax year to transfer in money from a Santander ISA account that I set up in the last tax year and only paid in to during the last tax year?
    I realise that this would mean setting up two cash ISA accounts in the same tax year, but one is with “new money” from this tax year, and one would be with “old money” from the previous tax year. Would that still be acceptable within the ISA rules with no penalty fees or loss of interest or tax?
    Thanks

    1. I find that many articles, every year, again and again, make statements offering advise that you can only open one cash ISA in a tax year. What should be written should be more on the lines of; you can only subscribe to one cash ISA in a tax year. This is what you have already done with the TSB.
      If you also want to transfer your Santander ISA to a Nationwide ISA you will need to complete a Nationwide ISA transfer form. On this form you’ll need to complete the Santander account details as well as the new Nationwide ISA account number. To obtain an account number you’ll need to open a new account (without depositing any other funds). Transferring an ISA is not counted as subscribing or part your annual allowance.
      If you’re in any doubt, speak to Nationwide.

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