The market for cash Isas has sprung back to life after years in the doldrums — and higher-rate taxpayers now have even more reason to consider their advantages.
Savings rates on cash Isas have languished since 2016, following the introduction of the personal savings allowance. This allowance meant most savers earning interest on cash in a non-Isa savings account would not pay tax on that interest. Basic rate taxpayers can earn up to £1,000 in interest before having to pay; higher rate payers up to £500; and additional rate payers receive no allowance.
Ultra-low interest rates contributed to this loss of interest in the tax-protected cash savings accounts. Customers looked elsewhere for better returns on their money, while banks no longer competed with each other to offer the best returns.
Over the past year, though, providers have responded to rising Bank of England base rates — now up at 4 per cent from 0.1 per cent in December 2021 — by raising their rates on a range of Isa and non-Isa savings accounts.
While the best rates on non-Isa savings deals across the market are typically still top of the table, Isas have rapidly caught up over the past few months.
Anna Bowes, co-founder of Savings Champion, a savings monitoring website, says: “For the first time in years, it feels as though there is a proper Isa season for cash savers.” It is no longer the case that you would be better off outside a cash Isa, she adds. “The gap has narrowed considerably between the two.”
The average one-year fixed rate bond offers interest at 3.65 per cent this month, according to Moneyfacts. The Isa equivalent is 3.56 per cent. This time last year, those averages were 0.89 per cent and 0.72 per cent respectively.
But the rise in these interest rates makes it much more likely customers with substantial savings will hit their annual tax-free limit than in the previous era of ultra low rates.
A higher rate taxpayer (with a £500 annual personal savings allowance) would have needed to put £33,784 into a savings account this time last year to breach the limit, with the then-market leading rate for a one-year bond of 1.48 per cent. Today, with a one-year rate of 4.31 per cent from provider SmartSave, the same taxpayer would only need to hold £11,601 before crossing the line.
If you think you are far from hitting these sums with your cash savings, then the non-Isa account may remain the best bet. But for basic rate taxpayers who do find themselves paying tax on savings interest, a headline rate of 4.31 per cent on a one-year bond will fall to an effective rate of 3.45 per cent after tax, says Bowes. “If you have to pay tax on your savings, suddenly you’d be earning much less on the net rate than you’d be earning in your Isa.”
This calculation is set to affect many more people over the next few years, after chancellor Jeremy Hunt used his Autumn Statement to announce an extended freeze on the personal tax allowance until April 2028 as well as the thresholds for basic and higher rate tax. The additional rate threshold will fall to £125,140 from £150,000 from April, dragging more people into the highest rate.
As people’s income rises faster than the frozen thresholds over the coming years, more will fall into the higher income tax brackets, reducing their tax-free savings allowance. So the recent rejuvenation of the cash Isa market is set to continue for at least the next few years.
Cash Isas are not the only protected option for those with money to stash away. Some may prefer to invest in a stocks and shares Isa, but have yet to make a decision on where to invest it.
In such cases, they can use part or all of their £20,000 allowance to place the cash in a stocks and shares Isa before the approaching deadline of April 5, shielding it from tax while they weigh up their options.
“Once an Isa allowance is loaded up with cash, investors have the luxury of time to make their investment selection, even drip feeding the money slowly into the markets at regular intervals to take advantage of pound-cost averaging to cushion the effects of any short-term volatility,” says investment platform Bestinvest.