Tax on savings is changing, so do you still need an ISA?

Radical changes announced in the Budget mean that, from April next year, most people will be able to earn up to £1,000 interest a year on their current or savings account completely tax-free.

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At the moment, interest is automatically taxed at 20%, and higher rate taxpayers have to pay another 20% via their annual tax return.

So does that mean tax-free individual savings accounts (ISAs) will no longer necessarily be the best option for taxpayers who don’t want to hand over any of their interest to the taxman?

But do the changes actually mean cash ISAs are now redundant? Here we explain why you SHOULDN’T consign them to the scrapheap just yet…

What’s changing?

From April next year, if you’re a basic rate taxpayer, you’ll be able to earn up to £1,000 of savings interest without paying 20% tax on it.

If you’re a higher rate taxpayer, you’ll be able to earn the first £500 of interest tax-free, rather than paying 40% on it. 

So, if you pay tax at the basic rate, you should be able to save around £70,000 without paying tax on the interest you earn (if you’re getting interest at the leading rate of around 1.5% in an easy access account).

If you pay tax at the higher rate, then you’ll be able to save around £35,000 before you have to pay any tax on your interest.

The changes mean 95% of us won’t have to pay any tax at all on our savings income. You read more about what else happened in the Budget here.

So where does that leave ISAs?

If you’re planning on building up your savings over several years, ISAs could still come in handy if you want to avoid paying tax on your interest.

If you’re planning on building up your savings over several years, ISAs could still come in handy if you want to avoid paying tax on your interest

You might think you’ll never build a cash savings pot of £70,000, but if your ISA allowance can be used as a tax shelter if there comes a point you’re earning more than £1,000 in interest from savings accounts.

Remember, interest rates won’t be this low forever, so when they rise, you might reach that £1,000 threshold sooner than you think.

ISAs have been around for a long while too, so there’s a chance they will last longer than this new savings measure – which is anyway vulnerable to a change of government at the General Election in May.

And if you already have a decent-sized pot of savings, then ISAs will allow you to keep growing them and pay no tax, as you get a new allowance every year.

This tax year (2014/15) you can invest up to £15,000 into ISAs, either in cash or stocks and shares, or a combination of both.

Next tax year (2015/16), which starts on April 6, the limit rises to £15,240, and soon you’ll have the flexibility to take out cash and put it in again without your money losing its tax-free status.

Stocks and shares

You might decide that, when the rules change next year, you’ll use your ISA allowance for stocks and shares and keep your cash savings in savings accounts.

You’ll need to have an appetite for risk though, as you could get back less than you put in. You must also remember that stocks and shares are a long-term investment.

That means you should only go for a stocks and shares ISA if you can afford to tie up your money for at least five to 10 years.

Seek professional independent financial advice if you’re not sure where to invest.

Best homes for your cash savings

Whether you put your money into a normal savings account or a cash ISA, it’s important to hunt out the best possible returns.

Don’t forget current accounts often offer great rates of interest too.

Here are some of the market-leadings savings accounts and ISAs currently available:

Cash ISAs

- Hinckley & Rugby Building Society’s 120 Day Notice Cash ISA Issue 2 pays 1.60% on a minimum investment of £500. You have to give 120 days’ notice if you want to make a withdrawal.

- NS&I’s easy access Direct ISA pays 1.50% on a minimum investment of £1.

- The Post Office’s Online ISA Easy Access Issue 1 pays 1.50% on a minimum investment of £100. The rate includes a 0.85% bonus for the first 12 months.

Savings accounts

- Coventry Building Society’s PostSave Easy Access (2) account pays 1.40% on a minimum investment of £500.

- Virgin Money’s Defined Access E-Saver account pays 1.35% on a minimum investment of £1. The rate drops to 0.75% if you make four or more withdrawals a year.

- Saga’s Telephone Saver (Issue 16) pays 1.35% on a minimum investment of £1,000. Can only be opened by over-50s and the rate includes a 0.85% bonus for the first 12 months.

Current accounts

- TSB current account pays 5.00% on the first £2,000. You must pay in £500 a month and register for internet banking.

- Santander 123 account pays 1% on balances between £1,000 up to £2,000, 2% on balances from £2,000 up to £3,000 and 3% on balances over £3,000 up to £20,000. There’s a monthly fee of £2 and you have to pay in £500 a month and set up two direct debits.

- Halifax Reward account pays you £5 every month if you stay in credit, pay in £750 each month and pay out two direct debits. You get £125 for switching if you start the switch by April 5.

Please note: any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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