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.
What is a Cash ISA?
The whole point of a Cash ISA (or Individual Savings Account) is that any interest you earn is tax-free. So if you had £5,000 earning 1%, you’d get to keep all of the £50 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.
You can save up to £20,000 into a Cash ISA each financial year, though that limit is shared across other types of ISA such as the Lifetime ISA or Stocks & Share ISA.
But an ISA isn’t the only way to avoid tax on interest earned. There are allowances for low earners, Premium Bonds (more on both of those here) and, most importantly, the Personal Savings Allowance.
The Personal Savings Allowance
The Personal Savings Allowance (PSA) was introduced in 2016 to give pretty much everyone tax-free interest on savings from any source, not just ISAs. In fact, any earnings in an ISA or Premium Bonds don’t count towards your PSA.
The PSA works like this. If you are a zero or basic rate taxpayer (essentially you earn under £50,270), you can make £1,000 in interest in a year before you start paying tax on it.
If you earn a little more and pay 40% tax, then you still get an allowance, but it’s reduced to £500 a year. Additional rate taxpayers don’t get a PSA at all.
Whether you use your full allowance depends on two factors: How much you have saved and the rate you earn. This table assumes the money is all in a single account:
|Rate||Balance to reach £1,000||Balance to reach £500|
Is the Personal Savings Allowance enough?
Right now a 1.5% easy access savings account (from Chase Bank) is the best rate you’ll get on large sums. That means the £1,000 allowance limit is going to take a lot of cash to reach. – £33,333 before you hit £500 in interest, and £66,667 before you’d reach the full £1,000 PSA.
But it is possible to get better rates if you split your cash across a few higher-paying accounts that have lower limits on the balance eligible for interest. Could this make a difference?
This table shows some of the better-paying accounts you might have right now:
|Account||Max Balance||Rate||Earnings over 12 months|
|Virgin Money M Plus||£1,000||2.02% / *5.02% if switched||£20.20 / £50.20*|
|Claro app (iOS only)||£3,000||2%||£60|
|Natwest Digital Regular Saver||£1,000 (assuming you’ve already saved this)||3.04%||£30.40|
|Nationwide Flex Regular Saver||£200 a month / £2,400 a year||2.5%||£32|
|Total||£7,400||£142.50 / £172.60*|
That’s a hefty £7,400 held across four different accounts, more than many have in their savings. But the total interest you could earn this way is still well off the PSA limit.
To actually use your full allowance, assuming you put further cash in a Chase Bank account paying 1.5%, the balances still need to be huge. This next table shows the interest earned:
|Balance||Interest earned at 1.5%|
Combined with the previous £7,400, the total savings pots to earn more than £1,000 is roughly £64,000 and to pass £500 is just under £31,500.
These are very large amounts, much more than most of us have or need in savings. The general rule is that you only need three to six months of expenses covered in an emergency fund, though you might want more if your income is irregular.
And there could be more on top if you’re saving for something in particular, but most people most of the time won’t need to have more than £30,000 in savings, let along £60,000.
What if you go over the Personal Savings Allowance?
The biggest threat to your PSA is increasing interest rates. We’ve seen some big increases recently, and if there are further hikes from the Bank of England, we can expect this to continue (though it might make time). So there’s a chance your savings pot, especially if you are a higher rate taxpayer, will earn interest beyond the allowance.
It’s not just interest rate rises that could impact your PSA. You might get a pay rise that changes your allowance, or the government could decide to reduce or axe it completely (you never know).
If this happens you can obviously move excess money over to an ISA, but only amounts under £20,000 (the annual limit). And that amount assumes you haven’t used some of your ISA allowance on a Lifetime ISA or Stocks and Shares ISA.
If this cap worries you it might be worth putting some money into a Cash ISA each year as it’ll retain the tax-free status for subsequent years, and you can always transfer the money around for better rates. Premium Bonds are also an option.
But the interest rate on offer in the ISA also makes a difference. 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 then the tax-free part of an ISA does make a difference, making an ISA the best home for your additional savings. At the time of writing, the top option pays 0.9%, so worth it for higher rate taxpayers. But basic rate taxpayers should go for the 1.5% account.
Summary: Do you need a Cash ISA?
Most of us aren’t going to have enough in savings at the current rates to go near the allowance limit. If that’s your situation then go for the account that pays the highest rate, ISA or not.
If you think you will earn more than the PSA allows, I’d encourage you to just check you need that much money in cash. The general rule is you only need three to six months of emergency expenses available, or money for any short-term goals (eg a new car, house deposit, a holiday).
Beyond that you’re better off putting surplus money into your pension, investing or even overpaying your mortgage.
If, after all of these, you still have enough in cash that you’ll go over your PSA, then yes go for a Cash ISA.