A Cash ISA is a general savings account, except that you pay no tax on any interest. With that in mind, of course it’s better to save your savings in Cash ISA instead of a savings account, isn’t it?
Well, these days it’s not so easy, because Cash ISA has lost some of their brilliance in recent years. The reason is here.
What is ISA?
ISA stands for Individual Savings Account. It is a kind of product that has been around for more than 20 years. There are four main types:
- Stocks and shares ISA -This type of ISA allows you to keep your investment income tax free.
- Innovative means ISA -A specialist ISA enables you to invest in peer-to-peer transactions.
- Lifetime ISA -ISA targets first-time buyers, or those who are interested in saving for retirement.
- Cash ISA – An ISA where you can save without paying tax on the interest you earn.
Everyone receives an annual tax-free personal savings allowance that applies to all ISA types.
In the tax year 2021/22, the allowance is £ 20,000. It should be noted that if you do not use your allowance in a certain year, you will not be able to roll it in the next tax year.
How does a Cash ISA compare to a general savings account?
By now you have recognized that a Cash ISA is basically a general savings account. The only difference is that you do not pay any tax on interest.
This may seem like a big advantage in face value. However, there are two main reasons why you might consider opening a normal savings account at Cash ISA.
Reason 1: Savings accounts pay higher interest than cash ISA accounts
We all know that savings rates are currently very low from a historical point of view. At the moment, the highest interest rate on an easy-access savings account is available from Tandem Bank, which offers 0.65% AER variable interest. It closely follows accounts from Aldermore (0.6% AER variable interest) and Tesco Bank (0.59% AER variable interest).
Compare these easy-access accounts with the top cash ISA offers and get the highest interest rate of 0.6% AER that Synergy Bank offers. Paragon Bank, Leeds Building Society and Coventry Building Society all pay 0.55% AER variable interest on the account.
The difference in interest rates becomes clearer when looking at fixed-term accounts. Currently, you can earn 1.5% AER variable interest on one year fixed savings account through Atom Bank. Yet the highest interest rate of ISA for a fixed period of one year is 0.85% AER variable interest through Coventry Building Society.
For more rate comparisons, see our list of top-rated fixed-term savings and fixed-term cash ISA accounts.
Reason 2: Personal savings allowance means most do not pay tax on savings
It was taxable on any interest you earned on a general savings account. This is why Cash ISA products were more attractive the day before, especially since Cash ISA interest rates were more competitive!
However, after the introduction of personal savings allowance, the tax-free status of cash ISA accounts in 2016 lost their appeal. This is because the allowance allows most people to earn interest on a general savings account without paying taxes. Your personal allowance limit varies depending on how much you earn:
- Basic rate taxpayer Interest on a general savings account is entitled to 1,000 interest-free earnings per year.
- High rate taxpayers You can earn up to £ 500 per year before paying interest on a normal savings account.
- Additional rate taxpayers Do not qualify for the allowance.
With allowances in mind, if you are a basic or high-rate taxpayer, these liberal tax-free limits mean that you are unlikely to declare any tax on interest earned on a general savings account.
Take, for example, the easy-access savings account that provides 0.65% AER variable interest. Assuming that the interest rate will not change within the tax year, the basic rate payers will have to save about 5 155,000 in this account before paying any tax on the interest.
Meanwhile, high-rate donors will have to deposit £ 77,000 in the same account before interest is taxable.
How do I find the highest interest rate for my savings?
Whether you opt for Cash ISA or a general savings account, it is worth searching for the highest possible interest rate. To help you choose an account, check out our list of top-rated Cash ISA and General Savings Accounts.
Want to invest instead? If you want to invest instead of saving, it should be remembered that you can use your ISA allowance in a stock and share ISA. If you are new to investing, it is a good idea to read the basics of investing to understand the risks.
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Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in the future. The content of this article is for informational purposes only. It is not the purpose of any kind of tax advice, nor does it constitute it. Readers are responsible for doing their own due diligence and seeking professional advice before making any investment decisions.