As savings rates increase, you could be using up your Personal Savings Allowance more quickly than you anticipated

25th May 2018

Over the last 12 months, interest rates on best buy accounts have increased across the board – which is good news for savers.

And even better news is that while, as a whole, cash ISA rates still lag behind the equivalent standard accounts, over the last year best buy ISA rates have improved by the highest percentage.

For example, the top rate available on a two year fixed rate cash ISA has increased by over 35% since May 2017 – from 1.25% to 1.69% tax free/AER. Compare this to the top two year fixed rate bond, which has increased by a more sedate 22.73% - still a significant improvement however.

Similarly, the top easy access cash ISA rate available has increased by nearly 34%, from 1.01% 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 20% and, in fact, pays a lower gross rate of 1.32%.

The introduction of the Personal Savings Allowance (PSA) in April 2016 means that many savers no longer need to pay tax on their savings. Basic rate taxpayers have a PSA of £1,000 per year – so the first £1,000 of interest they earn on their savings (outside of 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.

12 months ago, the best easy access account was paying 1.10% - which meant that a basic rate taxpayer would have needed to deposit £90,909 before their PSA was fully utilised.

Today, with the best easy access account paying 1.32%, a lower deposit of £75,758 would produce more than £1,000 in gross interest.

For those who opened a one year fixed rate bond in May 2017, the best rate they could get was 1.50% - so any amount over £66,667 deposited would have produced more than £1,000 in interest. Today, with best buy rates as high as 1.95%, you would only need to deposit £51,282 to see your PSA fully utilised.

Whilst these are still significant sums, 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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