Updated 25 July 2017
Everyone now has a personal savings allowance, which grants basic rate taxpayers £1,000 of savings interest tax-free. Some have suggested that this means the death of the cash ISA for ordinary savers. But there are plenty of other reasons why it’s still a good idea to hang on to yours.
In 2015 UK taxpayers may have paid up to £1.3 billion more tax than necessary, purely as a result of not keeping savings in a cash ISA. The interest on ordinary savings accounts, though small, combined to produce a huge nationwide tax bill – all because these savings weren’t sheltered inside the tax wrapper of a cash ISA.
But as of April 2016, everything changed. The personal savings allowance made savings effectively tax-free for 95 per cent of people. Basic rate taxpayers can now earn up to £1,000 of interest before paying tax on it, while higher-rate taxpayers can earn up to £500 (additional rate taxpayers get no allowance). To put this in perspective, the highest rate easy-access savings accounts currently offer around 1.3 per cent, so you’d need around £77,000 of savings in one before you start paying tax on the interest.
The new personal savings allowance means that taxpayers can collectively avoid nearly £2bn of tax payments if (though it’s a big If) they save effectively. But this welcome change doesn’t mean that cash ISAs are now useless for most people – far from it.
Reasons to keep using a cash ISA
Obviously additional-rate taxpayers will still need their cash ISAs, as they don’t get a personal savings allowance. However, there are a great many more higher-rate taxpayers in the UK, and they only get half the basic allowance.
Low interest rates may seem like the new norm, but in the long term they will inevitably rise. For around half of the past 50 years savings interest has been 6 per cent or more, and was close to 6 per cent as recently as 2007. At 6 per cent interest, you would use up your savings allowance with the equivalent of one year’s ISA allowance. If you’re a higher-rate taxpayer, you’d use it up at just 3 per cent interest.
Even at the current low interest rates, just five years of saving the equivalent of the full ISA allowance would probably use up your tax-free allowance, so you’d start to be taxed on the interest. If you used an ISA, your savings would remain tax-free.
ISAs now come with a unique benefit: when you die you can pass on the tax-protected status of the savings to your spouse or civil partner. For instance, if James dies and leaves an ISA of £40,000 to Lisa, then Lisa can use the money to open a new ISA for the same amount, regardless of her own ISA allowance. This means the tax-free status of the money isn’t lost on James’s death. (However, you can’t pass on the tax-free status of savings to your children.)
There are now a lot of ordinary savings accounts and even current accounts that offer higher rates of interest than many ISAs – but lots of them have minimum monthly deposit requirements or other strings attached. ISAs remain competitive as straightforward ways to save, and are also more flexible than they used to be, since you can take money out and reinvest it without using up more of your allowance.
ISAs still have advantages over ordinary savings accounts despite the personal allowance. Although you can earn £1,000 of interest tax free on an ordinary account, that money will still count towards your income when you’re assessed for things like child benefits and your personal allowance. By contrast, ISA interest is completely outside your taxable income.
A word of warning: withdrawing your pension pot and placing it in a cash savings account is almost never the best thing to do with it. Nevertheless, a lot of people have chosen to do this. A large sum of money like a pension pot could very quickly use up your personal savings allowance, in which case an ISA would help (but again: seek financial advice on more appropriate options!).
Keeping track of your tax-free interest could be tricky. Remember, all interest counts towards the total, from all savings accounts, current accounts, credit unions and some National Savings products, and it will all have to be assessed either through PAYE or through your tax return. This could potentially turn into an administrative headache, especially if you are near the allowance threshold or the higher-rate tax band. For instance, if your total income (including interest) tips you into the higher rate band by just £1, you will lose £500 of savings allowance.
Part of TaxAction 2016 in association with