Should I bother with a cash ISA?
It is fair to say that the popularity of the cash ISA has waned in recent years, leading to savers questioning their value in today’s savings market, so you are not alone.
There are a number of reasons for this: One of the biggest recent impacts on cash ISAs was the introduction of the Personal Savings Allowance (PSA). The PSA now means that for many savers, paying tax on their savings is a thing of the past – which after all is one of the main advantages of choosing a cash ISA in the first place.
Another reason that cash ISAs could be less popular now is that, generally speaking, there is a gap between the best rates on offer, compared to standard savings accounts. If you can get a higher interest rate on a standard account - especially now that the interest is likely to be tax free because of the PSA – then it makes sense to stick to the accounts that give the best return.
However, there are a number of reasons why you shouldn’t dismiss cash ISAs out of hand and should still consider them as part of a balanced savings portfolio.
The cash ISA offers tax-free interest on the full balance held. Over the years, since the inception of the ISA in 1999, if you had utilised your ISA allowance each tax year, sizeable balances will have been accrued. If you make the most of your allowance each year going forward, you can potentially accrue similar amounts or even more, as the allowance has increased greatly. At the end of the day, if you don’t use your ISA allowance, you will lose it forever, reducing the amount you can save tax free in the future and reducing your potential tax-free savings pot.
It is also worth noting that there is a limit to the amount of interest you can earn tax free through the PSA. Basic rate taxpayers can earn up to £1,000 per tax year in interest before paying tax and the amount is £500 for higher rate taxpayers. Interest earned on cash ISAs does not count towards the PSA, so could prove extremely valuable if you are likely to earn more than the relevant PSA threshold or indeed if you are an additional rate taxpayer, who don’t receive any PSA at all.
We also shouldn’t forget that whilst interest rates are comparatively low, the amount of money you have in savings before you breach the relevant PSA threshold is relatively high. This means that if and when rates do go up to a higher level, it will take less money in savings to go above the PSA. In contrast, all money held in a cash ISA is tax free, regardless of the amount.
This goes back to what I was saying earlier about fully utilising your cash ISA allowance because if you don’t use it, it will be lost and you may then end up vulnerable to future changes in savings taxation. If the Government were to scrap the PSA in the future, the amount you hold in cash ISAs will still remain tax free. Whilst we don’t have a crystal ball, it would be reasonable to argue that there is more likelihood for a change in the PSA than retrospective action taken on cash ISAs already held.
In the short term, while interest rates are low and there remains a gap between the best rates available on cash ISA and standard accounts, there is an argument for sticking to standard accounts. But the cash ISA still has its advantages and so I would suggest you should consider both and not simply dismiss the humble cash ISA. After all, if you do not use your ISA allowance, the amount of money you can save tax free in the future could diminish, particularly if rates go up or there is a change in the rules. The key is to use all of the tools in your armoury to get the highest possible returns both now and in the future.
For more information, call one of our savings experts on 0800 321 3581 – or download our ISA Guide.