Rates slump kills off cash Isa tax savings

CASH Isas, once the darlings of the savings world, have now lost their tax-free advantage.

Isas protect savers from paying income tax on interest earned. But for the first time since cash Isas were launched in 1999, even after forking out 40pc in tax, you are no better off in a fixed rate Isa than an ordinary taxable account.

And for the first time in their 22-year history, money has flowed out of Isas for six months in a row.

Meanwhile, the nation is saving more. Money stashed in savings accounts was up 6 pc in the same six months to a record £1,392 billion, Bank of England figures reveal.

The gap between what you earn on an ordinary savings account and a cash Isa has widened dramatically in the past few months.

With cash Isas, the Government allows you to save up to £20,000 each tax year into these accounts and earn tax-free interest.

Isas first began to lose their appeal through a combination of low rates and the personal savings allowance.

Introduced five and a half years ago in April 2016, the personal savings allowance gives people who normally pay the basic tax rate of 20 pc, the first £1,000 of interest a year tax-free in an ordinary account. For higher-rate taxpayers the allowance is £500.

In recent weeks, the rates on one-year bonds have soared, doubling from their all-time low in April. Then the best rate was 0.6pc. Last Friday, Atom raised its rate to 1.5 pc.

Rates on cash Isas, however, have only limped up. The top figure, also announced on Friday, is just 0.9pc from Hodge Bank, up from 0.5 pc in April.

The reason for the lacklustre rates is lack of competition, with fewer banks offering cash Isa accounts.

Rachel Springall, finance expert at data firm Moneyfacts, says: ‘There are 78 banks competing for fixed-rate bond money, but half as many for fixed-rate Isas. There is a notable difference in the rates.’

Even if you pay tax — and few savers do with rates so low — you are still left with 1.2pc after basic rate tax on the top fixedrate bond. That’s a third more than the best tax-free cash Isa.

For higher-rate taxpayers, there is no advantage in Isas. They end up with 0.9pc after tax on the fixed rate bond, the same as in the best one-year fixed rate Isa.

The latest Bank of England figures show that £2.6billion has been withdrawn from cash Isas in the six months to the end of July. In the same period, £51.3 billion has found its way into taxable easy-access accounts and fixed-rate bonds.

With interest so low, a basic-rate taxpayer can have £65,000 in a fixed-rate bond at 1.5 pc and only earn £975 interest a year.

A higher-rate taxpayer can have £32,500 in bonds and their interest will still be under the taxable threshold.

On easy-access accounts, the picture is better. The top rate of a cash Isa is 0.6pc from Cynergy Bank, against 0.65pc on an ordinary account with Tandem Bank.

Even so, savers can still squeeze more interest outside an Isa than within, thanks to the personal savings allowance.

Basic-rate taxpayers can put a huge £150,000 in accounts paying 0.65 pc yet only earn £975 interest a year. For higher-rate taxpayers the figure is £75,000.