Is a cash ISA still the best place for your savings?

THE ISA has traditionally been seen as a haven for savers who want a tax-free investment vehicle, but this week I’m going to challenge the received wisdom surrounding this and look at whether your money is better off elsewhere.

Since its introduction in 1999, people have been piling their money into ISAs because the interest earned is tax free. This money tends to stick around for longer because savers think they have something of value that they don’t want to lose, which banks and building societies like.

But the reality for most people is that they can earn more in a normal savings account and the interest will still be tax free under the Personal Savings Allowance (PSA) rules introduced in 2016.

Basic rate taxpayers can earn up to £1,000 in savings income tax-free, while for higher rate taxpayers this figure drops to £500. This is separate to your annual £20,000 tax-free ISA allowance.

This means that providing you don’t earn more than your PSA your money might be better off in a savings account that pays a higher rate of interest, rather than an ISA.

Banks and building societies won’t tell people this because they would prefer to pay 0.5% interest to someone rather than 0.75%. To them it’s extra money that they can lend on to someone else and make a profit on.

It’s also something for them to hang their hats on as well. When it gets to the end of the tax year and the ISA allowance deadline approaches there is the motivation for people to do something about it and they can market this accordingly.

Consequently more people push money into ISAs, whereas there’s no real motivation to market a standard savings account each year as there’s no deadline for contributions.

In terms of cash ISAs there’s an argument to say that a lot of people are not earning as much as they could be and that they might actually be better thinking about having cash investments not in ISAs but in other savings accounts where they will benefit more.

For example, Santander offers the 123 Account where on balances of up to £20,000 you can earn around 1.5% (variable) interest which is more than you’ll get on an instant access ISA at the moment. So why wouldn’t you have one of these if all you’ve got is £20,000 to save?

If you’ve got £40,000 why wouldn’t you have £20,000 in a 123 Account and £20,000 in another account that’s paying more than an ISA?

Now, I’m not saying don’t use your ISA allowance, I’m just saying that where you can get a better rate of interest elsewhere you might as well do that because you’re not paying tax on the interest anyway because of the PSA and you’ve still got your ISA allowance available to use on growth assets, such as unit trusts or investment trusts.

Imagine if you have £100,000 in an ISA earning 0.5% but a standard account pays 1% – your interest will still be tax free but you’ll get £1,000 instead of £500 each year.

I’m not suggesting that people seriously consider shifting all their money out of an ISA into a higher paying account, but they ought to seriously consider whether they put any more money into ISAs because there seems to be little or no advantage in doing it.

The conventional thinking has always been to max out your ISA allowance first and then look for other areas to place your money, but as you can see these days this is perhaps not the case. Remember, the value of your investments can go down as well as up. Past performance is not a reliable indicator of future outcomes. Andy lives in Wokingham and has worked as a financial adviser for over 30 years. He is married with three grown-up children. Faron Partnership offers personal financial advice, including retirement, investment and estate planning. Any information or views expressed in this article should only be acted upon within the context of your own circumstances with the help and guidance of a professional financial adviser. Faron Partnership Ltd is an independent financial adviser which is an appointed representative of ValidPath Ltd which is authorised and regulated by the Financial Conduct Authority.