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The worthy successor

It was on 5 March 2009 when the Bank of England base rate hit its lowest ever level, 0.5 per cent, following six consecutive months of decreases.

As the UK reeled from one shock after another and the biggest financial crises on record took hold, we had seen the rate plummet from 4.5 per cent in October 2008, down to 3 per cent in November, before finally ending up at its current historically low level, where it has remained for three years.

So, with little prospect of the base rate picking up soon, have Isas, the successor to the tax-exempt special savings accounts, remained as popular as when they were launched, way back in 1999, when the Bank of England base rate was 5.50 per cent?

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The short answer is yes, despite these historically low interest rates. When you look at HMRC statistics, 4.5m savers opened a mini cash Isa in the 1999/2000 tax year compared to 11.9m in the 2010/2011 tax year, a significant increase in just over a decade.

It is easy to see why cash Isas are popular with the many institutions’ customer base. First of all, savers receive their interest tax-free, without the deduction of 20 per cent, 40 per cent or 50 per cent, depending on the rate of tax they pay. Second, for those customers who have used up all of their Isa allowances since the account was launched, they have over £50,000 invested plus any interest earned over the last 12 or so years. Furthermore, if they also put in the maximum allowable into a Tessa, then they have built up tax-free savings of almost £60,000 (£59,280 to be exact), plus capitalised interest.

Therefore, if you take a competitive one-year fixed rate Isa, paying 3.35 per cent, the annual return would be £1986 on a savings balance of £59,280. A standard rate taxpayer in a non-Isa account would only receive £1589, with a higher rate (40 per cent) taxpayer receiving £1192 on the same basis. Even in the current rate environment, differences of £397 and £794 a year respectively are not to be sniffed at. Remember also, that this return is calculated only on the initial amount invested and it would be an even greater loss when you add in the benefit of the capitalised interest built up over the 12-year period.

Another way to look at this is to consider, in percentage terms, how much more interest you can earn in an Isa. Using the examples above, an extra £397 in interest represents another 25 per cent to a basic rate taxpayer, and an additional £794 represents an additional 66.6 per cent in interest to a 40 per cent taxpayer. I appreciate it is just another way of looking at the numbers but it certainly highlights that maximising a tax-free allowance is well worth doing.

Earnings

According to HMRC, the average annual subscription in cash Isas has increased from £2520 at launch to £3190, with the total amount subscribed at over £38bn in 2010/2011 compared to £12.3bn in 1999/2000.

This is probably as a consequence of a number of factors. The profile of Isas has risen significantly since launch. Pick up any national paper and this will be full of useful information and best-buy tables during the Isa season, which is generally from the beginning of March to the end of April including the tax year end, and start of the new one. There has been some flight to safety since the onset of the credit crunch and savers have been putting their cash on deposit with safe UK institutions. The final factor is that the annual cash tax-free allowance has increased recently from £3000 a year (1999 to 2008), to £3600 (2008/2009), £5100 for all savers in 2010/2011, £5340 in 2011/2012 and to an all time high of £5640 from 2012/2013. With the end of the current tax year approaching, many savers will be looking to top up this year’s subscription to the maximum.