In recent years, interest rates on best buy accounts have been steadily increasing across the board, having hit a low following the cut in the Bank of England base rate in August 2016.
But this means that savers will be using up their Personal Savings Allowance (PSA) with a far lower deposit today than previously.
Basic rate taxpayers have a PSA of £1,000 per year – so the first £1,000 of interest they earn on their savings (outside a cash ISA) each year is tax free. Higher rate taxpayers’ PSA is £500 per year.
The knock-on effect has been to make it more difficult to decide whether to use your cash ISA allowance or not, as the tax savings may not be worth it.
With cash ISA rates often paying less than the gross rate of the non-ISA equivalent, for many savers, choosing a cash ISA right now would often see them earning less interest.
However, with best buy rates increasing, savers might find themselves having to pay tax on their savings unnecessarily, if they have shunned their ISA allowance.
For example, in October 2016, the best easy access account was paying 1.01% - which meant that a basic rate taxpayer would have needed to deposit £99,010 before their PSA was fully utilised.
Today, with the best easy access account paying 1.35%, a lower deposit of £74,074 would produce £1,000 in gross interest, a drop of 25%.
If you had taken out a one year bond on 1st October 2016 – just after the base rate was cut in August that year – you would have needed £71,429 to achieve £1,000 gross interest and therefore fully utilise your basic rate taxpayer PSA.
With today’s top rate of 2.05%, a saver would need only £48,780 to achieve £1,000 interest – a drop of 32%.
And the good news is that while, as a whole, cash ISA rates still lag behind the equivalent standard accounts, over the last year, best buy cash ISA rates have improved by the highest percentage.
For example, the top rate available on a one year fixed rate cash ISA has increased by 29% since July 2017 – from 1.20% to 1.55% tax free/AER.
Compare this to the top one year fixed rate bond, which has increased by a more sedate 10% - still a significant improvement however and still paying significantly more at 2.05% gross/AER.
Similarly, the top easy access cash ISA rate available has increased by 23%, from 1.10% tax free/AER 12 months ago, to 1.35% tax free/AER today.
In contrast, the best non-ISA easy access rate has increased by just 8% and now also stands at 1.35%, so there is no compromise between picking the best buy ISA over the best buy standard account.
It’s easy to see how quickly the value of the PSA will decrease as rates rise. Whilst you can still save significant sums without breaching the allowance, you can see that as interest rates increase, holding a cash ISA may become more important – so it’s worth taking another look at this humble stalwart of the savings market. It could save you from paying unnecessary tax in the future.
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