Months of volatile returns on equities have caused many investors to seek shelter in cash. But with the average instant access account paying just 0.81 per cent, according to the Bank of England, the only way to ensure a real return any cash deposit right now is to find the highest possible rate – and pay no tax on the interest. And the easiest way to do that is through a cash individudal savings account (Isa).
First introduced by the government in April 1999, cash Isas are tax-free savings accounts available from most banks and building societies.
Since April 6 2008, individuals have been allowed to save up to £7,200 in an Isa each tax year, but with only £3,600 permitted in a cash Isa with a single provider. Savings over £3,600 can only be invested in a stocks and shares Isa, either with the same provider or a different company.
Which type of cash Isa you use will depend on your attutude to risk, and your need for quick access to cash. Most cash Isas let you make withdrawals, although you may have to give notice to avoid a penalty.
“A prospective investor should assess what kind of access they require: easy access, notice, or are they prepared to lock money for a period of time, say one or two years?” says David Black, principal banking consultant at Defaqto.
“Easy access” Isas allow exactly that: savers can get their money out immediately. However, once the maximum annual allowance has been placed in an Isa, it cannot be topped up during the same tax year if a withdrawal is made. So, for example, someone investing the full £3,600 and withdrawing £2,000 a month later, will not be able to save any more in an Isa until the next tax year. “More than one cash Isa can be held and be open but these must have been opened in different tax years,” explains Black.
If a cash Isa is your preferred option, then it is simply a question of finding the best fixed, or variable, interest rate.
But this has become more difficult, following eight reductions in the Bank of England base rate. In January 2008, the average interest rate paid on on £3,600 in a cash Isa was 5.49 per cent, according to Defaqto.
Today, that figure has dropped to 2.65 per cent. Some, such as Halifax’s Isa Saver account, pay just 0.1 per cent on balances under £3,000.
Given that the full impact of last month’s 0.5 per centage point cut has yet to be felt by savers, let alone this week’s further cut of the same amount, the average could easily fall below 2 per cent from next month.
These low rates have caused some savers to withdraw their funds. Some £163bn is now sitting in cash Isa savings accounts, but as fears over the economy and the safety of financial institutions have increased, withdrawals have become more frequent.
“Bank of England interest rate cuts and inflation that still refuses to drop to 2 per cent mean savers are having to work extremely hard not to see their money lose value,” points out Kevin Mountford, head of banking at moneysupermarket.com.
“Fewer than 8 per cent of savings accounts are now helping taxpayers beat inflation, with good easy access accounts being the hardest to find,” he adds.
He says the problem is worst for higher-rate taxpayers, and the only accounts worthy of their consideration are 27 cash Isas.
“The government has a short-term objective to get the tills ringing but it needs to think longer term about the nation’s need to save,” argues Mountford. “It should provide savers with incentives such as a sizeable increase in the Isa allowance, or, even better, the complete removal of tax on interest earnings.”
This week, the highest rate on an easy-access Isa was 3.6 per cent from Scottish Widows Bank E-Cash Isa. Standard Life Bank Direct Access Isa was offering 3.5 per cent. Alliance and Leicester Easy Isa and Manchester Building Society Premier instant Isa were both paying 3.5 per cent.
If you do not mind locking your money away for some time, Birmingham Midshires one-year fixed rate Isa is paying 3.5 per cent. But this is a notice account, so you will need to give 90 days’ notice if you want to withdraw your money.
Halifax’s fixed-rate cash Isa will pay 4 per cent but has an early exit penalty for anyone taking their money out before the four-year term is up.
Savers need to check all of these terms, and be aware of “bonus” rates which may only be short term, says Black.
“Some banks launch Isas with high rates of interest, only to drop them a few months later. This is fine as long as savers keep a note of when their bonus rates will fall and are ready to switch again to a better rate.”
However, if you are going to switch, you need to ask your existing Isa provider to make the transfer for you, direct to the new Isa provider.
If you withdraw the cash yourself, you will not be allowed to reinvest it in another cash Isa in the same tax year, because you have already used your annual allowance once.
