ISAs Explained

11th August 2017

Since December 2016 we have seen the rates of top fixed-rate cash ISAs increase by as much as 42% as smaller banks attempt to establish their business.

As everyone in the UK who's 16 or over gets a Cash ISA allowance at the start of each tax year (the minimum age is 18 for other types of ISA), in the third part of our savings guide, we look at ISAs in more detail and the different options available on the market.

 

So, when is a Cash ISA worth it? On 6 April 2016, the personal savings allowance (PSA) was introduced, meaning all savings are now automatically paid without tax deducted at source. Basic 20% rate taxpayers can earn up to £1,000 of savings interest a year without needing to pay tax on it and higher 40% rate taxpayers can earn £500 pa (additional rate 45% taxpayers do not receive any PSA).

The most important thing to note is that cash ISA interest doesn't count towards your PSA, so you can earn it tax-free and still have your full £1,000 (or £500) PSA allowance. Therefore, for top-rate taxpayers or savers with larger balances, who've used up the PSA, there remain big tax advantages.

Also, it's worth remembering that while £1,000-a-year interest seems a lot now with interest rates so low, if rates rise, then more people will need to pay tax. So, saving into an ISA now could protect you from future tax on some of your savings. 

An Individual Savings Account (ISA) is simply a tax free ‘wrapper’ offering you a tax break, so that you are sheltered from some or all of the tax on the investment. Every year, all UK residents aged from 16 have an annual ISA allowance. For this tax year (2017/18), the total ISA allowance is £20,000. You can choose to put the whole allowance in a Cash ISA, or from the age of 18 invest in a stocks and shares ISA, an Innovative Finance ISA, a Lifetime ISA or have any combination of the four types, up to the maximum allowance. 

 

Cash ISAs

 

No tax is payable on the interest earned in a Cash ISA, so if you’ve not used up your ISA allowance, you could be paying more tax than you need to.  Even non-taxpayers should consider a Cash ISA as, over time, the amount they build up in this tax-free wrapper could become considerable; yet, under current legislation, they’ll never need to pay tax on it, even if their circumstances change.

Like savings accounts in general, Cash ISAs come in many shapes and sizes. They can offer easy access to your money, access by giving notice or they can be fixed term accounts. A new type of Cash ISA was launched in December 2015, the Help to Buy ISA, which is designed to help first time buyers to get on the property ladder, and most recently the Lifetime ISA, was launched in April 2017, although currently only one provider is offering a Cash Lifetime ISA – Skipton Building Society.

For more information on Cash ISAs, please contact us on 0800 321 3581for a copy of our free Cash ISA Guide.

 

Variable Rate Cash ISAs

As the name suggests, the rates on these accounts are variable and come in two main varieties, easy access and notice ISAs. Just like the non-ISA equivalents, easy access ISAs allow you to get at your money without giving any notice or paying penalties. However, whilst they are straightforward, just like their non-ISA counterparts, there are sometimes introductory bonuses to watch out for, where the interest rate drops like a stone after the initial period, which is typically 12 months. There are also Cash ISAs that limit the number of penalty free easy access withdrawals you can make in a year and if you fall foul of the rules, a much lower interest rate then typically applies for the rest of that year.

As always, make sure you carefully study the terms and conditions of the ISA before going ahead and if you go for one of these accounts, plan your withdrawals carefully or ensure that you know when your bonus ends. As mentioned earlier, our free Rate Tracker service can help you with this by sending you a reminder when your bonus ends.

Notice ISAs again work in pretty much the same way as a standard notice accounts and can generally offer you higher returns in exchange for restricting access to your money. For those happy to sacrifice easy access and can plan withdrawals carefully, notice ISAs can work well. Notice periods can vary between accounts and are not always a better option in terms of interest rate than some easy access ISAs, so make sure you look at a selection of different types of account before taking the plunge.

For a selection of the best-paying easy access and notice ISAs on the market, please refer to our Variable Cash ISA Best Buy table.

 

Fixed Rate Cash ISAs

Fixed Rate Cash ISAs are similar to standard fixed rate bonds in many ways, offering a fixed return for a fixed term. One of the main differences between Fixed Rate Cash ISAs and Fixed Rate Bonds is that some form of access to your funds has to be offered with a Cash ISA, whereas you cannot access your money at all with most fixed rate bonds. To access a fixed rate cash ISA there is usually a hefty penalty involved, so whilst the facility is there, it is still advisable to make sure you can tie funds up for the term before proceeding.

The term usually ranges between 1 and 5 years and the longer you tie your money up, the higher return you receive. Obviously, this is not always the case, with rates varying wildly between providers, so make sure you look at the top rates available from the whole of the market before going ahead. If you are looking for independent, whole of market information, as with any type of savings account, take a look at our Fixed Rate Cash ISA Best Buy Tables.

 

Help to Buy ISAs

This type of Cash ISA is designed to help first time buyers get onto the property ladder and have been around since December 2015. First time buyers can save up to £200 per month (plus an additional £1,000 in the first month only) which then goes towards the purchase of their first home. In addition to the interest earned on the money held in the account, the Government adds a bonus of 25% of the balance when the purchase goes through, from a minimum of £400 up to a maximum of £3,000. The addition of the Government bonus is a good incentive for first time buyers to save regularly and whilst arguably the icing on the cake, there are some attractive interest rates on offer currently as well.   

For more information on Help to Buy ISAs - click here to view our factsheet and for the latest rates, take a look at our Help to Buy ISA Best Buy Table.

 

Junior ISAs

As mentioned previously in part two of our guide to savings options for children, a Junior ISA (JISA) is a type of tax-free savings account which is opened on behalf of a child. Accounts can be topped up by parents, friends and family up to an annual limit, which is currently £4,128 in the 2017/18 tax year. Like adult ISAs, JISAs are available in both cash and stocks and shares varieties.

JISAs were introduced in November 2011, replacing Child Trust Funds. This meant that some children were stuck in these accounts, whilst providers focused their attention (and rates) on the newer Junior ISAs. Luckily, the change in rules in April 2015 meant that those holding Child Trust Funds can now choose to transfer to a Junior ISA, meaning that they do not miss out on some of the higher returns available.

JISAs are opened by a parent or legal guardian on behalf of a child, with the money in the account belonging to the child, although it cannot be withdrawn until they turn 18. Parents, friends and family can all contribute to the Junior ISA, as long as the total amount stays within the annual limit, so it can be a great way of building up funds for the future. 

The main advantage of a Junior ISA over a standard children’s savings account is that parents can contribute into this account without falling foul of the tax rules that limit the interest on gifts from parents to less than £100 per year, per parent. To clarify, if money given to a child by a parent outside a JISA earns gross interest of more than £100 in any tax year, the parent is taxed on all the interest at the parent’s marginal rate. At an interest rate of around 3%, a parent would fall foul of this rule on savings of around £3,300 and as the amount saved increases over time, it could have a significant impact going forward.

 

Lifetime ISAs

The latest addition to the ISA family is the Lifetime ISA, which works in a similar way to a Help to Buy ISA, but allows those under the age of 40 to not only save towards their first home but could alternatively put money towards their retirement and benefit from a 25% Government bonus. The bonus can only be used for one of two goals at the present time, but it does allow people already on the property ladder to benefit from that Government incentive. You can save up to £4,000 per year in a Lifetime ISA and the Government bonus is added annually until April 2018 and then monthly from then on in.

Lifetime ISAs can be either stocks and shares or Cash ISAs, although there is only one cash Lifetime ISAs at the time of writing. Hopefully, the market will pick up soon and there will be more competition in the market, but watch this space and we will bring you developments as and when we get them.

For more detail on Lifetime ISAs – click here for our factsheet or for those looking to compare the new offering with a pension, we have produced aLifetime ISA v Pension  factsheet to highlight the differences between the two.

 

ISA Transfers

Of course, if you are not happy with the interest rate you are getting or would like to switch to a different type of ISA, this is where ISA transfers come in. Transferring your ISA to another provider ensures that not only can you pick a more suitable option for you, but if the process is followed correctly, the money stays in the ISA wrapper and does not affect the current year’s ISA allowance.

Approach the provider you would like to transfer to and they will help you with the paperwork and request the transfer on your behalf. Never take the money out of an ISA yourself with the intention of moving it elsewhere, as that money will no longer count as ISA money and will count towards your annual allowance if you attempt to pay it in, something that will be impossible if you have already paid into an ISA already in that tax year.

If you need any help or guidance with an ISA transfer, please do not hesitate to get in touch and call us on 0800 321 3581.

 

And finally, once you have chosen the best savings account, it’s no good simply forgetting about it; you need to keep an eye on the rate to make sure it remains competitive. Again, we can help. If you sign up to our Rate Tracker service, we’ll let you know when the rate changes on your account and how it compares to the top rates on the market. And if you sign up to our Rate Alerts, we’ll let you know when new accounts come to the market, so you can see if something better has become available that you might want to switch to.

At, Savings Champion we monitor the whole of the savings market, so please call us on 0800 321 3581 for more information on the best type of savings account for you.

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