Cash Isas are still a great way to build up an emergency buffer or to save for a particular need, says David Prosser
Time is running out to use your 2024-25 individual savings account (Isa) allowance: once the tax year ends on 5 April, any unused Isa allowance for this year is gone for good. And as you consider your options, don’t assume an investment Isa is the only game in town – a cash Isa could be an excellent alternative.
Cash Isas are tax-free bank and building society accounts; you’re depositing your cash, earning interest on the money, but with no need to pay tax however much your savings grow.
As with investment Isas, you can put up to £20,000 into a cash Isa in the current tax year. But while investment Isas are typically used to hold assets such as stock market shares, which can fall in value as well as rise, money in cash Isas is secure – there is no risk of losses.
Cash Isas can thus be a good foundation for your savings and investments. Personal finance experts often advise holding six months of salary or so in a rainy-day fund in case of emergency – cash Isas are a good option here.
They can also be a great place to hold savings earmarked for use in the short- to medium term – for a deposit on a home, say, or a family requirement – as you don’t have to worry about the possibility of the cash losing value just when you need to use it.
The value of tax-free interest
In recent years, some analysts have questioned the value of cash Isas as tax-efficient savings vehicles. The Personal Savings Allowance allows people to earn up to £1,000 of interest on deposits each year with no tax to pay, they point out.
That could make cash Isas redundant, particularly during times when interest rates are low, and savers are not earning so much income on their cash.
However, that argument overlooks several issues. First, as you build up savings over time, you’ll earn more interest – eventually you’ll run out of Personal Savings Allowance and face a tax bill. If interest rates rise, this may happen sooner than you expect. Cash Isas provide a means to head off this danger.
Moreover, the £1,000 allowance isn’t available to everyone. The rapidly growing number of higher-rate income taxpayers in the UK only get an allowance of £500 each year. And if you’re an additional-rate taxpayer, you don’t get a penny of Personal Tax Allowance; you’ll pay up to 45% tax on all the interest you earn.
Cash Isas are therefore particularly attractive to higher- and additional-rate taxpayers – and, critically, basic-rate taxpayers heading towards those tax brackets; savings interest itself could even tip you into a higher rate of tax if your earnings already take you close to the personal tax thresholds.
And with these thresholds frozen until at least 2027-28, more and more people will have to worry about reduced savings allowances.
What to look for in a cash Isa
To get the best out of a tax-free cash Isa, you need to be earning as much interest as possible – that way, you’ll be saving even more tax. As with other types of savings accounts, rates vary widely from one provider to the next, so it’s important to shop around carefully for the best deal.
You’ll also need to decide what type of account you want. One option is a variable-rate product, where the provider can move your interest rate up and down – often following the Bank of England’s base rate announcements.
These accounts may be instant access, enabling you to withdraw cash whenever you like, or require you to give notice of withdrawals. Notice accounts sometimes pay higher rates of interest but typically penalise you if you take cash out without giving enough notice.
Alternatively, fixed-rate cash Isas pay a set rate of interest over a specific term. At United Trust Bank, we have a range of products between 1 and 7 years, with a fixed rate of interest, that can be found here.
Fixed rates can provide useful certainty about your future income, but it’s possible you could lose out if variable rates move higher. You will also likely face early withdrawal fees if you take money out before the end of the term.
The right deal for you will partly depend on why you’re saving. If you’re building up a emergency cash buffer, say, you’ll want easy access to the money without penalty. If you know you’re not going to touch the cash until, say, you buy a house in five years’ time, you can afford to lock it up if doing so will net you more interest.
Stay vigilant on interest rates
You can move some or all of your money from one cash Isa to another without losing your tax advantages. This is important because it enables you to go on taking advantage of the best interest rates.
Over time, the account you choose this year may look less good compared to other products. This year’s cash Isa may include a bonus interest rate that expires after a set period, say. Or other providers may decide to compete harder for savers’ cash.
It’s important to keep scanning the market to identify the best cash Isa deals. Transferring money invested in a previous tax year doesn’t affect your cash Isa allowance in the current tax year. But you do need to do it in the right way to protect your tax advantages: ask the new bank or building society to arrange the transfer rather than trying to withdraw your cash and reinvest it.
You should also check up on costs before transferring. Some providers may levy charges on transfers. And if you currently have a notice account or a fixed-rate deal, there may be early withdrawal penalties to pay.
Finally, it’s useful to know that some cash Isas are “flexible”. This means you can take cash out and then put it back in during the same tax year without reducing your Isa allowance for the year. It is worthwhile checking with the provider if they offer this feature.
* AER stands for Annual Equivalent Rate and illustrates what the interest rate would be if interest was paid and compounded once each year.
Although this email and article may contain helpful information and tips, these are not personal advice. If you are unsure what’s best for your own personal circumstances, you should seek advice from an independent financial adviser (IFA).