For more than 20 years, millions of savers have relied on Individual Savings Accounts (Isa) in cash to protect their savings from the tax authorities. But the death knell is now sounding for cash Isas as savers seek better rates available in the wider savings market.
The latest government statistics show the amount Isas paid in cash has fallen by £12billion over the past year. One of the main reasons for this is the shockingly low interest rates that most banks and many building societies offer savers – a fact highlighted by The Mail on Sunday’s Give Savers A Rate Rise campaign.
Over the past 12 months, a widening gap has developed between the interest rates banks are willing to offer on standard savings rates and what Isa savers can get.
Breaking the bank: The latest government statistics show the amount paid in cash by Isas has fallen by £12billion over the past year
For example, savers looking for a new account can get a better purchase rate of 2.57% fixed for a one-year bond with Cynergy Bank.
In contrast, the best Isa equivalent comes from Virgin Bank at 2.25%, resulting in £126 less annual interest on £20,000.
On a two-year fixed rate savings bond, the best rate is from Cynergy Bank at 2.88%. The best Isa equivalent is from Virgin Bank at 2.25%, resulting in £126 less annual interest on £20,000.
For three-year fixed rate savings bonds, the best rate (again) is Cynergy Bank at 2.9%. The best Isa three-year savings bond cash comes from the Buckinghamshire Building Society at 2.3% – an annual interest shortfall of £120.
Step away from the best buy deals and the chasm between cash Isa rates and traditional savings account rates is even starker.
Research by financial data monitor Moneyfacts indicates that more than half of banks and building societies pay a lower interest rate on their cash Isas than on their standard savings accounts.
In some cases, individual banks pay up to six times more interest on their ordinary accounts compared to their Isa equivalents. High street banks are the exception (see box below) – but only because their standard savings account rates are often just as low.
“It’s shocking that cash Isas often pay so much less than their non-Isa counterparts,” says Anna Bowes, co-founder of rates reviewer Savings Champion. “Paying lower than standard rates is a blow to savers.”
A striking example of how cash Isas lag behind standard accounts comes from Al Rayan Bank. Its one-year fixed-rate savings bond yields a competitive rate of 2.4%. But its cash equivalent Isa only pays 0.4%.
So deposit £20,000 into the standard account and you’ll earn interest over the life of the £485 bond. Opt for the duty-free account and you’ll only get £80 – missing out on £405 in interest.
On Friday, Al Rayan Bank said: “Cash and term deposits are two different sets of products.” The government gave Isas money a hammer blow in 2016 when it introduced the Personal Savings Allowance.
This allows basic rate taxpayers to earn up to £1,000 in interest per tax year before they start paying tax on their savings income – and higher rate taxpayers up to £500 . The allowance is not available to those earning more than £150,000 a year.
This means a base rate taxpayer can save up to around £38,500 in Cynergy Bank’s best one-year bond buy without worrying about tax. For many savers, this renders cash Isas and their deplorable interest rates useless.
Bowes said: “In the past I have always urged taxpayer savers to make sure they don’t miss the opportunity to tuck away some of their hard-earned savings in a tax-free Isa fund. . But the introduction of the Personal Savings Allowance changed things. Additionally, many banks have failed to raise cash Isa rates to those available on their other savings account offerings.
Bowes says one of the reasons cash Isa rates are being scrapped is that they are more expensive for banks and building societies to operate – ensuring savers don’t breach or abuse not Isa rules.
Sarah Coles, personal finance analyst at Hargreaves Lansdown, says many small savings organizations do not operate in the cash Isa market, which reduces competition.
“With a smaller number of accounts on offer, you don’t get the same level of competition that pushes rates up as you do in the broader savings account market,” she says.
What savers need to do depends on the amount of their savings and their tax bracket. For example, someone with £100,000 sitting in a cash Isa could move it to the best one-year Isa fixed rate with Virgin Bank and receive £2,000 in interest over 12 months.
A base rate taxpayer could roll it over to a one-year non-Isa account with the best buy, with Cynergy Bank paying 2.57%. They would earn an annual interest of £2,570, of which £1,000 is non-taxable and £1,570 is taxable at 20%.
The overall interest they would get is £2,256, which would make them £256 better than being in Virgin Bank’s best cash equivalent Isa account.
The numbers for a higher rate taxpayer are different. Given that they only receive an annual personal savings allowance of £500, moving the same £100,000 from a best buy, a one year fixed rate cash Isa to an equivalent non-Isa n wouldn’t make sense.
Of the £2,570 of interest they receive, £2,070 would be taxed at 40%, giving an annual net of tax interest of £1,242. The other question to consider is what happens if your salary goes up or if interest rates go up.
If your salary goes up, you could go up a tax bracket and see your personal savings allowance cut in half or disappear altogether. You may then fancy the protection of a cash Isa, but then you will only be able to replenish your cash Isa kitty at a rate of £20,000 per tax year. Similarly, as savings rates increase in response to increases in the bank’s prime rate, more savers will begin to earn interest above the annual personal savings allowance, resulting in a tax on the surplus.
“There are people for whom an Isa cash is always the right choice,” insists Coles. “They include supplemental rate taxpayers and higher rate taxpayers with large savings balances.
“An alternative solution is to ditch your cash-based Isa in favor of an investment-based Isa. Although stock markets are in volatile mode, the long-term returns on equity investments historically exceed anything you can get with cash, and investment returns could beat inflation, which saving in species simply cannot do.
Shaun Moore, tax and financial planning expert at wealth manager Quilter, says: “Even the best interest rates on Isas cash right now won’t do anything to stop the rotting effect of inflation on the saves people who lose value all the time.”
Switch that earns you ten times more
Most major banks currently pay more interest on their easy-access cash Isas than on equivalent non-Isa accounts.
But experts say savers at big ISA banks shouldn’t stay put – they should transfer their balances to a provider paying much higher interest rates.
According to data from rate finder Savings Champion, a client of NatWest Cash Isa is currently receiving a paltry 0.1% interest, which equates to £20 annual interest on £20,000 in savings. Still, if they transferred their Isa to Paragon Bank (triple number 8) paying 1.2%, they could increase their annual interest by £220 – provided they were comfortable with only three withdrawals are authorized per year on the Paragon account. .
Halifax Isa Saver Variable Saver pays 0.2% interest – more than the equivalent Everyday Saver bank’s instant access account which pays 0.15% interest. Still, moving to Paragon still makes financial sense. Among the big banks, Santander’s eIsa (operated via mobile or online banking) is the most attractive easy-access cash ISA, paying 0.7% (0.8% if you’re a “ selected” from Santander).
That’s far better than the 0.25% he pays on his equivalent eSaver account, but the £140 annual interest doesn’t stand up to Paragon’s £240.
“Shopping always pays off when looking for the best Isa cash rates,” says Anna Bowes of Savings Champion.
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