We all know it’s important to have some readily accessible cash set aside for unexpected circumstances but, as most of us have more complex financial issues to think about, it’s often tempting to select the first available option when it comes to cash savings accounts.
However, it’s vital to get a feel for the different options available before committing to an account that might not give you the best possible rate of return on your hard-earned money. For example, if you’re not yet taking advantage of your annual cash ISA allowance, you could be missing out on £5,640 in tax-free savings.
What are cash ISAs?
An individual savings account, or ISA for short, is a way of saving money in a tax-efficient way. Each eligible person (those over 16 who are UK residents or Crown employees) has an annual cash ISA allowance, which is currently set at £5,640 and is set to rise to £5, 760 for the 2013/14 tax year.
Why save using a cash ISA?
No tax will be deducted from interest earned on the money you save in a cash ISA. This is particularly good news for higher and additional rate taxpayers because you would usually pay tax of 40% and 50% respectively.
Cash ISA are also relatively simple and easy to use, even for novice savers. If you choose an instant access cash ISA you’ll still have easy access to your money, should you need it. Similarly, if you find an ISA provider that offers a better deal than your current provider, you can transfer your cash ISA to them.
How do cash ISAs differ from TESSAs and PEPs?
Individual Savings Accounts (ISAs) were introduced in the UK in 1999. They replaced older tax-efficient savings schemes including Personal Equity Plans (PEPs) and Tax-Exempt Special Savings Schemes (TESSAs).
How do cash ISAs work?
ISAs are not investments in themselves - instead, they act as tax 'shelters', protecting your cash or investments from tax. Under the 2012/13 total ISA Allowance of £11,280, individuals are permitted to save up to £5,640 in a cash ISA. With a cash ISA, money is placed on deposit and all interest is paid gross without any tax having been deducted. Money can be paid into a cash ISA as a lump sum or in regular amounts.
There are limits on the number of ISAs you can subscribe to each tax year. Current ISA rules allow each individual to have one cash ISA and one stocks and shares ISA per tax year.
Many ISA providers will accept ISA transfers from other providers, so if you're not happy with how your ISA is performing you have the option of voting with your feet. You can move your money if your existing ISA provider becomes uncompetitive and you find that you can get a better rate of interest elsewhere.
An instant access cash ISA might be a good choice if…
- You want a good rate of interest, plus the ability to get hold of your money quickly if necessary.
- You want to take advantage of your annual tax-free savings allowance but only have a small amount to deposit - instant access ISAs can be opened from as little as £1.
- You want to be paid regular interest - instant access ISAs usually offer monthly or quarterly interest.
A fixed-rate cash ISA might be a good choice for you if…
- You are happy to put your money aside for a set period of time - this usually allows you to accrue a higher rate of interest than you might get with an instant access cash ISA.
- You want to take advantage of your tax-free savings allowance and have a lump sum to deposit - many fixed-rate cash ISAs require an initial deposit of around £1000.
Deposit Plan Cash ISAs – an alternative to fixed rates
Given that current fixed-rate cash ISAs are offering low interest, some savers are turning to structured deposit plans to fill the gap. These plans allow you to expose your cash ISA savings to the stock market, and potentially earn returns on this, without risking your initial capital. As with any new savings product, seek independent financial advice if you’re not sure.
Choosing a cash ISA
Like any investment option or financial service, it's important to research your options before committing to a cash ISA. You might find our services useful for:
Comparing cash ISAs, including instant access ISAs and fixed-rate ISAs
Comparing cash ISAs with other savings options