A cash Isa used to be the obvious first choice for all savers, as the interest earned is tax free – always.
And in the past, there have been fierce battles to attract cash Isa customers – with best buy cash Isas often out-stripping the rates on non-cash Isa best buys, making them the first option, even for non-taxpayers – something that savers today will probably find hard to believe.
But, much has happened over the years, in particular the introduction of the funding for lending scheme (FLS) in July 2012 – which prompted best buy cash Isa rates to fall by as much as 60 per cent.
Savings allowance
Then the personal savings allowance (PSA) was introduced in April 2016.
When the PSA was introduced, the government announced that 95 per cent of savers would no longer be paying tax on their savings because basic rate taxpayers can now earn up to £1,000 per year in savings interest tax free and higher rate taxpayers can earn up to £500 per year. Additional rate taxpayers do not have a PSA, so they need to pay tax on all savings interest outside an Isa.
The FLS and PSA have had a dramatic impact, reducing both the rates and the popularity of cash Isas.
As a result, today there is a big gap between best buy cash Isas and the non-Isa equivalents, with the latter often paying far more in gross interest.
This means that for many savers who are not paying tax on their savings – as the interest they are earning is within their PSA – there is little incentive to open a cash Isa. It is now much more difficult for them to decide whether to bother with a cash Isa or not, unless they are additional rate taxpayers or are fully utilising their PSA.
Understandably this has resulted in a drop in the popularity of cash Isas, but it is important not to simply dismiss them out of hand.
Over the last year, best buy cash Isa rates have been improving faster than rates on best buy non-Isa accounts, so although there is still a long way to go to return to pre-FLS levels, things are moving in the right direction and the gap is beginning to narrow.
Remember, if you do not use your Isa allowance, it is lost forever as you cannot go back and use it retrospectively. As a result, if circumstances change, for example if interest rates rise, which means your PSA is used more quickly, or should the PSA be abandoned, you could end up paying more tax on your savings in the longer term.
It is also disappointing that many providers had turned their backs on the humble cash Isa, but as mentioned above, the rates on offer have improved significantly over the last year – with best buy rates up by over 45 per cent.
Challenger banks
This is due in part to the fact that more challenger banks have added cash Isas to their range of savings accounts. As well as the likes of Virgin Money, which has been very active in the market for years, new banks such as Paragon Bank and OakNorth Bank are also now regularly featured in the cash Isa best buy tables.
But that is the key – best buy Isa rates are improving, so loyal savers who have stuck with their high street banks are missing out on valuable tax-free interest, compared with the best deals on the market.
Although the cash Isa rates on offer from the UK’s biggest banks, pay higher rates than their non-Isa equivalents, they still pale into insignificance when compared to the best on the market. For example, Santander’s Easy Isa is paying just 0.10 per cent, whilst Shawbrook Bank’s Easy Access Cash Isa – Issue 2 is paying 1.25 per cent tax free/AER – over 12 times more.
And those who are unlikely to make many withdrawals could earn even more if they are happy to be restricted to just one withdrawal a year – Nationwide’s Single Access Isa is paying 1.30 per cent tax free/AER.
Savers who fail to move their money from these lower earning accounts are allowing themselves to be robbed, as they are missing out on additional tax-free interest compared to the top-paying accounts.
A general malaise has spread across the savings market because of the continual low rates of interest available. But savers need to realise that the high street banks are using this to offer them much lower rates than they can get elsewhere because of the feeling that there is not much to be gained by switching.
But that is most definitely not the case. By moving from some of the lowest paying accounts with the likes of Santander, to the top-paying account paying 1.30 per cent, on a deposit of £20,000, that is the difference of earning either £20 a year or £260 a year in tax-free interest.
Another issue that is likely to have hampered the popularity of the cash Isa is simply the complexity that has increased over the years. Rules on Isas are strict and numerous and the different types of Isa to choose from have also increased.
Navigating the Isa market may sometimes feel like crossing a minefield and too much choice and complexity means that many will decide to simple leave them well alone – which is a shame, as they will potentially miss out on the valuable tax breaks that an Isa can bring.
Anna Bowes is a director of Savings Champion
