As we move into so-called ‘ISA season,’ you may be thinking about putting money into a cash ISA (individual savings account), or revisiting an existing cash ISA to see if you can better the rate you’re currently getting.
‘ISA season’ refers to the period leading up to the end of the financial year when people race to use up their annual tax-free allowance before the April 5 deadline.
As a saver, you may know that with a cash ISA, your interest is tax-free. You might also know that the allowance for the 2020-21 tax year is £20,000.
However, when it comes to these products, there are a lot of wrongly-held assumptions.
Here we try and clear up some of the confusion around cash ISAs, and set out some of the key things you need to know – helping you to take advantage of the benefits offered by these tax wrappers.
Under rules introduced in 2016, basic-rate taxpayers can earn £1,000 a year in interest from ordinary savings accounts without having to pay tax. This is known as the ‘personal savings allowance.’
But having this allowance doesn’t do away with the need for cash ISAs. Putting money in a cash ISA is about future-proofing your hard-earned cash against interest rate rises and changes to the tax system.
If, say, the interest rates paid on savings go up, or if the ‘personal savings allowance’ goes down – or gets withdrawn – at some point in the future, you could face tax on your savings a lot sooner.
Equally, if at some point you find yourself as a higher-rate taxpayer, perhaps after a pay rise, your tax-free limit will fall to £500, meaning you can only earn this amount before having to pay tax.
A cash ISA can be a valuable tax shelter, helping you protect your savings from tax, for the long term.
Generally speaking, as a saver, you can find that rates on cash ISAs are slightly lower than the rates paid on standard savings accounts – though right now, you can actually get a better on an easy-access ISA than on a non-ISA account.
Fixed rate accounts are following the more traditional pattern, with rates on standard fixed-rate savings accounts currently slightly higher than equivalent rates on cash ISAs. That said, the difference is so tiny that once you start paying tax on savings, cash ISAs soon begin to offer better value.
Even though rates on cash ISAs are low at present, this should not deter you from comparing deals. You could still get a better rate on your hard-earned cash by switching.
If you’ve compared rates and found the rate on your current cash ISA can be bettered, you must first check that ‘transfers in’ are permitted. If the answer is yes, you must not transfer the money yourself, as if you withdraw the money, your savings pot will lose its tax-free status.
It’s essential you follow the simple transfer process, using a transfer form which your new provider will give you. The transfer will then happen electronically.
You can put up to £20,000 a year into an ISA, and you get a new allowance each tax year.
Crucially, though, you cannot carry over your allowance. If you don’t use it, you lose it.
When taking out an easy-access cash ISA, you need to read the small print carefully, as while some will offer unlimited withdrawals, others may only permit, say, two or three penalty-free withdrawals a year.
If you think you are likely to need access to your cash more often, this may not be such a good option.
The lifetime ISA is a product designed for savers trying to amass a deposit for their first home.
With one of these products, you get a 25% bonus from the government, worth up to £1,000 a year if you save the maximum of £4,000 a year. In total, you can get up to £32,000 towards your first home.
If you have no immediate plans to buy a property, you may think it’s not worth opening one of these accounts. But even if your home-ownership plans are some way off, it’s still worth getting a lifetime ISA now, as you need to have an account open for 12 months before being able to use it to purchase a property.
You also can’t open a lifetime ISA once you turn 40, as the scheme is only open to those aged between 18 and 39. So, if you’re approaching this cut-off point, you should open an account sooner rather than later, or you could miss out altogether.
Finally, it’s important to note that with a lifetime ISA, you can withdraw the money penalty-free if you are using it for a first-time house purchase. But if you withdraw the cash for any other reason, you will be subject to a 25% charge.
That said, if you wait until after you turn 60 to withdraw the money, this 25% charge will no longer apply, meaning you can also use the money to help fund your later life.