February magazine column
Should I save in a Cash Individual Savings Account (ISA)?
As we approach the end of the tax year, we enter what has historically been dubbed ‘ISA season’. This is because March and April typically saw savers looking to max out their ISA allowances before the end of the tax year and then take advantage of the allowance in the new tax year. Providers saw a spike in new applications around this period compared to the rest of the year.
This has waned in recent years for three main reasons:
- The increase in allowances – the 2020/21 ISA maximum investment is £20,000. A saver looking to max out two tax years allowance therefore needs £40,000, which is beyond all but a small percentage of the population.
- The introduction of the ‘Personal Savings Allowance’ in 2016 - this means banks now automatically pay interest without tax deducted. Basic rate taxpayers can earn £1,000 in savings interest before they need to pay tax and higher rate taxpayers can earn £500 in interest before paying tax. Around 95% of savers no longer pay tax on their savings.
- Interest rates are typically lower – as banks and building societies have to allow access to ISAs, more so than on non-ISA accounts, rates on ISAs have fallen and have often been 25 – 30% lower than non-ISA accounts.
Are cash ISAs irrelevant now?
For the vast majority of savers, there will be little or no immediate financial benefit to open a Cash ISA instead of a traditional savings account. However, there are some exceptions and the following types of people should still consider them:
1) Existing Cash ISA savers
Anyone who has opened an ISA every tax year since 1999, and used the full allowance, has been able to shelter over £181,500 plus interest from the tax man and, in April, will be able to add further to that. We won’t know until the budget on March 3rd what the allowance will be in 2021/22 but I expect it to be the same, which will mean those savers who have used the allowance every year will have in excess of £200,000 saved. If you already have cash ISAs from previous tax years, it is worth considering retaining them to keep those tax-free allowances.
2) Additional rate taxpayers
Those taxpayers who earn over £150,000 a year pay 45% tax and get no personal savings allowance so should definitely consider cash ISAs.
3) First Time Buyers
Lifetime ISAs, known as LISAs, are available for those aged 18 – 40 and you get a 25% bonus from the government each year on top of anything you save. First time buyers who save £4,000 get a £1,000 from the government. The bonus is paid every year until the saver is 50 years old.
There was little consultation from the government before LISAs and, as a result, there are only five providers of a cash LISA, Moneybox, Paragon Bank, Skipton, Nottingham and Newcastle Building Societies. Nottingham pays 0.80% interest on their LISA, which is very attractive compared to the best easy access account which is Marcus paying 0.50%.
Those saving for a home will find the 25% bonus very attractive and should certainly consider a LISA if they are saving for a deposit, but only if they will definitely buy a house with it or don’t need that money before they are 60. This is because, if you take some or all of the money out of it before then (other than to buy a property) you pay a 25% penalty on it.
This doesn’t put you back where you started, it makes you worse off. For example, if you saved the full £4,000 and got the £1,000, you have £5,000 (ignoring interest). A 25% penalty on that means you repay £1,250 so are £250 down on what you put in.
Although this penalty has been reduced to 20% for this tax year, so savers can’t lose money on what they put in, it is due to go back up next tax year. The Chancellor could extend this, or change it to 20% permanently, in the budget but there are no guarantees he will.
4) Savers who may need access to their cash
Savers looking at easy access may want to consider a cash Isa because they actually pay similar or slightly better rates e.g. Al-Rayan’s cash easy access ISA pays 0.60% versus Marcus’ 0.50% for ordinary easy access savings.
Savers considering fixed-rate bonds but who want access to the cash during the term might prefer the flexibility that fixed rate ISAs have. Almost all cash ISA fixed rate bonds allow some form of access with a penalty interest charge.
Will the budget bring any cheer for savers?
Sadly, I fear that there will be nothing in the budget for savers. I expect the ISA allowance will be frozen again at £20,000, which is where it has been since April 2017. The only area I could see a surprise is if the Chancellor chooses to fund some of the covid measures by raising money from savers. This was something which was done after World War 2 and it has been mooted that this could be repeated.
Either way, I will update readers in my next column!