🔔 Are Cash ISAs worth another look?

As we head into February, this is traditionally when the ISA season begins to kick in. In the past, we would have been urging tax paying savers to ensure that they didn’t miss out on the chance to shelter some of their hard-earned savings in a tax free cash ISA. After the 5th April each year, if you haven’t used your ISA allowance, you lose it – it can’t be carried over.

However, the introduction of the Personal Savings Allowance (PSA) in April 2016 changed things, as the PSA means that basic rate taxpayers pay no tax on the first £1,000 of interest earned each year, while for higher rate taxpayers they have a £500 allowance. Additional rate taxpayers don’t receive a PSA, so nothing has changed for them.

At the time the PSA was introduced, HMRC declared that around 85% of savers would no longer pay tax on their savings, and as interest rates have fallen, I expect even more people would have fallen into this camp.

As a result, the importance of the Cash ISA has waned and according to figures from the Bank of England, the amount held in Cash ISAs has been falling – especially since the interest rates on offer have fallen lower than ever.

But with two base rate rises under our belt, and talk of more to come, will people need to turn back the Cash ISAs to keep their savings as tax efficient as possible?

Currently, basic rate taxpayers in the best unrestricted easy access accounts on offer, with Investec and Cynergy Bank paying 0.71%, will breach the PSA with a deposit of £140,846. For higher rate taxpayers it's £70,423.

But if interest rates were to increase, the amount at which savers will breach the PSA will fall. Before the Pandemic caused the base rate to be cut twice, the best easy access account was paying 1.41% AER. At this rate, a basic rate taxpayer would need to have just £70,922 to breach the PSA.

At the moment though, Cash ISA rates are far lower than the non-ISA equivalents, so it’s hard to know what the best thing to do is.

The best easy access ISA is paying just 0.60% tax free, however this is greater than the net rate would be for those who have to pay tax on their savings. After tax the gross rate of the best easy access non ISA rate of 0.71% is netted down to 0.57% - so those breaching the PSA would be better off with the ISA.

The situation is not quite the same for Fixed Rate ISAs as the gap between the best ISA and the best non ISA equivalent is much wider. For example, the best 1-year bond is paying 1.36% gross which after basic rate tax is deducted, is 1.09% net. The rate of the best 1-year cash ISA on the other hand is just 0.98% tax free. Incidentally, with a rate of 1.60%, a basic rate taxpayer will breach the PSA with a deposit of just £62,500!

So unless you are worried that you might breach the PSA in the future if and when rates finally start to rise, and unless Cash ISA rates recover, you could be better off without, or even better off if you do need to pay some tax.

That said, although in the short term, while rates are low, opting to use the PSA before using your Cash ISA may be the better option, if and when rates do eventually start to rise, the amount at which savers can save tax free will diminish, if they are only utilising the PSA. So our suggestion would be to consider both - don't simply dismiss the humble Cash ISA.

Of course regardless of which route you choose, the overwhelming problem at the moment  is inflation, which is set to increase further still following the increase to the energy cap, announced on Thursday.

So for those who don’t need to keep all their money in cash, remember that there is also the option to invest into a stocks and shares ISA.

If you are worried about low savings rates and higher inflation and might like to consider other options available for your ISA allowance this year and in April, why not speak to one of our team about what might be available to you. Call our colleagues at The Private Office on 0330 323 9065, or contact us here.