Tax-free savings: Cash ISAs vs Personal Savings Allowance
Money is pouring out of Cash ISAs as the once popular savings accounts lose ground due to a change in the tax rules.
Last April the Personal Savings Allowance was introduced. It allows basic-rate taxpayers to earn up to £1,000 interest a year before Income Tax is levied. This change has meant many savers no longer see the point in Cash ISAs as they can earn tax-free interest in standard savings accounts.
"The change in tax rules, allowing £1,000 of interest to be earned tax-free, has clearly reduced the attraction of cash saving in ISAs," says Eric Leenders, head of personal finance at UK Finance.
The demise of Cash ISAs has been compounded by the fact there are numerous traditional savings accounts offering higher rates of interest.
In June, a whopping £1.7 billion was pulled out of Cash ISAs, according to figures from UK Finance. That is the largest amount since records began over a decade ago. In contrast, £6.5bn was deposited in taxable savings accounts.
But, abandoning your cash ISA could well be a mistake. Here are four reasons to keep yours:
They're tax-free regardless of income
The Personal Savings Allowance changes depending on how much you earn.
A basic-rate taxpayer can earn up to £1,000 a year before Income Tax is due, but the allowance halves if you are a higher-rate taxpayer and additional rate taxpayers get no personal savings allowance at all.
That means if you get a pay rise that pushes you into a different tax bracket you could find your savings are suddenly liable for Income Tax.
There's no limit on interest
As a nation, we've endured low-interest rates for the better part of a decade. That means you can put a lot of money in a traditional savings account and be safe in the knowledge your returns won't exceed the Personal Savings Allowance.
With interest rates on savings accounts hovering around 1% a basic-rate taxpayer could deposit up to £100,000 before they need to worry about tax.
But, interest rates will rise eventually and when they do you could find you have to start paying tax on your savings because you've exceeded the Personal Savings Allowance.
For example, a savings account paying 1% interest can hold up to £100,000 before tax is due. But, if interest rates rose to 3% a basic rate taxpayer could only save £33,000 without tax being due.
Money in a Cash ISA is tax-free regardless of how much interest you earn.
Money in a Cash ISA is tax-free no matter how big your savings pot grows.
The only limit is on your annual deposit – currently £20,000 a year – so you could gradually shield hundreds of thousands of pounds from the taxpayer over the years.
Anyone who had saved the full annual ISA limit since their launch in 1999 would have over £1 million tucked away and growing tax-free now.
If you rely on the Personal Savings Allowance to protect you from the taxman you need to keep a close eye on how much you are saving.
The allowance applies to all your savings regardless of how many accounts it is spread across so you'll need to do your sums to make sure new deposits and compound interest don't gradually nudge your returns over the allowance.
With a Cash ISA, as long as you don't exceed the deposit limit each year and stick to the rules on only opening one Cash ISA a year you are safe from the taxman.
They can be inherited
The Personal Savings Allowance is non-transferable so when you die any savings you pass on to other people will be liable for Income Tax at that person's marginal rate if the interest returns take them over their own personal savings allowance.
In contrast, married couples and civil partners can inherit their other half's ISA pots. The year you die they will receive an increase to their own annual ISA allowance – known as an Additional Permitted Subscription - to reflect the balance of the ISAs you pass on to them. This allows them to re-invest the money in ISAs in their own name so the money can continue to be protected from the taxman.
So, if you died this year with ISAs worth £50,000 your spouse or civil partner would get an ISA allowance of £70,000 for the 2017/18 tax year (£50,000 plus their own £20,000 annual ISA allowance).