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Are ISAs worth it? Top accounts pay up to 5.2% – but why some savers are avoiding them
Plus, we've explained how to find the best savings rates
WITH interest rates finally falling, savers are more eager than ever to find the best ways to maximise their returns.
Individual savings accounts (ISAs) offer tax-free savings on up to £20,000 a year - but if your saving less than this then there could be a better alternative. James Flanders explains...
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If you save into an ISA, you can stash away up to £20,000 a year tax-free, and you don't pay tax on any money in this account - no matter how much interest you earn.
On the other hand, with a regular savings account, basic rate taxpayers have to pay tax on their savings if they earn more than £1,000 in interest annually.
Higher-rate taxpayers must pay tax on savings as soon as they earn more than £500 in interest annually.
This is what's known as the personal savings allowance, which was first introduced in 2016.
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So how much do you need to have saved before you pay tax and want to consider an ISA?
Sarah Coles, head of personal finance at Hargreaves Lansdown, said: "If you're a basic rate taxpayer with £19,000 in savings at 5.25%, you'll need to consider tax.
"If you're a higher rate taxpayer, this will kick in once you have £9,500."
Historically, only higher earners have been hit with tax bills for saving their cash.
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However, when interest rates rose from lows of 0.2% in February 2022 to a high of 5.25% in August 2023, more savers found themselves liable for the tax.
Rachel Springall, personal finance expert at MoneyFacts, said: "Over the years, ISAs have been an essential way for consumers to protect their savings returns from tax, and they are still worth taking advantage of today.
"As interest rates rose sharply last year, those savers who decided to invest their cash outside of an ISA wrapper may breach their personal savings allowance (PSA)."
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WHAT ARE THE BEST SAVINGS RATES?
The top rates for ISAs and savings accounts are similar.
The best easy-access cash ISA currently pays 5.2% from Trading 212 and you can start with just £1.
The best fixed ISA currently offered is Punjab National Bank, which pays 4.80% (but requires a minimum investment of £1,000).
Whereas the best easy-access savings account that isn't an ISA is from Ulster Bank, which pays 5.2% - but you need to pay a minimum of £5,000 and be a current account customer.
The next best account is from Principality Building Society, which pays 5%. You need £1 to open the account, but you are limited to three withdrawals a year.
The best 6-month fixed bond is from ICICI Bank paying 5.21% and you need £1,000 to open the account.
Whereas Union Bank of India pays 5.25% on its one-year bond, but you need £5,000 to open it.
IS AN ISA RIGHT FOR YOU?
It depends on your circumstances.
If you were looking to lock your cash away for a year and had £5,000, then it would make sense to choose the Union Bank account fixed bond rather than an ISA.
You'll earn more interest and won't pay tax this year.
But as your savings add up, you may end up paying tax.
Sarah said: "The benefits of a cash ISA don't start and end with the tax saving today.
"If the frozen income tax thresholds mean pay rises push you into a higher tax bracket, the ISA will be more rewarding."
For example, if you're suddenly pushed into the higher tax bracket, your personal savings allowance will be cut in half from £1,000 to £500.
So, if a higher-rate taxpayer had £10,000 in the top-paying fixed bond from Union Bank of India, earning 5.25% in interest, they would earn £525 each year.
This would then breach the personal savings allowance and mean they need to start paying tax on their savings.
This means that if you're a higher-rate taxpayer and have more than around £9,500 in savings, you should put it in an ISA.
Sarah added: "Likewise if the government decides to cut the personal savings allowance, you'll be grateful for your ISA."
"By using a savings account, average earners with modest savings might be reasonably sure they won’t pay tax on their savings this year.
"By using an ISA, you can be certain to protect your savings from tax forever."
The best thing to do is research based on your circumstances.
Rachel added: "Consumers with only small nest eggs can earn more interest in a non-ISA, and depending on how long their cash is invested, they might not come close to breaching their personal savings allowance."
FINDING THE BEST SAVINGS RATES
WITH your current savings rates in mind, don't waste time looking at individual banking sites to compare rates - it'll take you an eternity.
Research price comparison websites such as Compare the Market, Go Compare and MoneySupermarket.
These will help you save you time and show you the best rates available.
They also let you tailor your searches to an account type that suits you.
As a benchmark, you'll want to consider any account that currently pays more interest than the current level of inflation - 2%.
It's always wise to have some money stashed inside an easy-access savings account to ensure you have quick access to cash to deal with any emergencies like a boiler repair, for example.
If you're saving for a long-term goal, then consider locking some of your savings inside a fixed bond, as these usually come with the highest savings rates.
WHAT'S NEXT FOR SAVINGS RATES?
Savings rates usually rise and fall with the Bank of England's base rate.
This was cut for the first time in four years from 5.25% to 5% earlier this month.
And markets are pricing in one further rate cut in 2024.
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If forecasts are correct, the base rate could fall to 4.75% by the end of 2024.
That's bad news for savers, whose rates typically fall when the Bank's rate is cut.
SAVINGS ACCOUNT TYPES
THERE are four types of savings accounts fixed, notice, easy access, and regular savers.
Separately, there are ISAs or individual savings accounts which allow individuals to save up to £20,000 a year tax-free.
But we've rounded up the main types of conventional savings accounts below.
FIXED-RATE
A fixed-rate savings account or fixed-rate bond offers some of the highest interest rates but comes at the cost of being unable to withdraw your cash within the agreed term.
This means that your money is locked in, so even if interest rates increase you are unable to move your money and switch to a better account.
Some providers give the option to withdraw, but it comes with a hefty fee.
NOTICE
Notice accounts offer slightly lower rates in exchange for more flexibility when accessing your cash.
These accounts don't lock your cash away for as long as a typical fixed bond account.
You'll need to give advance notice to your bank - up to 180 days in some cases - before you can make a withdrawal or you'll lose the interest.
EASY-ACCESS
An easy-access account does what it says on the tin and usually allows unlimited cash withdrawals.
These accounts tend to offer lower returns, but they are a good option if you want the freedom to move your money without being charged a penalty fee.
REGULAR SAVER
These accounts pay some of the best returns as long as you pay in a set amount each month.
You'll usually need to hold a current account with providers to access the best rates.
However, if you have a lot of money to save, these accounts often come with monthly deposit limits.