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Three months in and PSA sees ISA rates plummet

Three months in and PSA sees ISA rates plummet

Category: ISAs

Updated: 20/07/2016
First Published: 20/07/2016

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

It's now been three months since the personal savings allowance (PSA) was launched, and there was much speculation that it'd decimate the ISA market. So, three months in, has it had the expected impact? Unfortunately, it looks to be the case…

Fresh lows

While rates across the savings market have been hit recently, it's the ISA sector that's experienced the strongest downturn, with our figures showing that the average one-year ISA rate has fallen by 0.08% to 1.14% in the last month – the first time that the rate has fallen below 1.20% – while the long-term equivalent fell by 0.07% to 1.39%, dipping below 1.40% for the first time on record.

The notice cash ISA rate saw an equally substantial drop of 0.06% to stand at 1.07%, while the no notice ISA rate remained unchanged at 0.98%, making it the only rate to be unaffected this month. Nonetheless, this and all other ISA rates are now the lowest ever recorded, and in some cases, they're now fairly comparable with traditional savings accounts – and in the fixed sector, average ISA rates are now lower than their non-ISA equivalents, making them far less appealing than they once were.

PSA to blame…

While there are several factors that could be influencing these rate cuts – the fact that ISA rates were typically higher so there's been more opportunity to reduce them, for example, not to mention base rate and providers' general lack of need to raise funds – it's arguably the PSA that's had the most overriding impact in recent months.

Indeed, average ISA rates have plummeted particularly sharply since the scheme was launched – the average one-year ISA rate has fallen by 0.17% since April, while the long-term rate is down by 0.21%, the no notice ISA rate by 0.07% and the notice equivalent by 0.09%, providing further evidence of the PSA's impact on the sector.

But why? Well, the scheme, which means that up to £1,000 in interest can be earned tax-free each year, regardless of where money is held, could have led providers to wonder whether it's still worth competing in this area – which could, in turn, have fuelled the reduction in ISA rates.

Consumers, too, could be wondering if they should continue investing in such accounts, which could simply be because many of the former benefits of ISAs are no longer there: not only are average rates now comparable with their non-ISA counterparts, but the PSA means that savers can get tax-efficiency without needing to sacrifice flexibility, and with the majority of providers seemingly unwilling to offer flexible ISAs, is it any wonder that savers are turning their backs on them?

… but don't give up on ISAs

Rates may have fallen dramatically in recent months, but that's no reason to give up on ISAs altogether. Sure, the PSA sounds appealing – most people won't have a sufficient savings pot to earn interest over the £1,000 threshold, so they'll be achieving tax-free returns without needing to put up with the rigidity, particularly in terms of investment limits, of an ISA.

But what would happen if the PSA rules changed, or the scheme was scrapped altogether? This would mean your savings pot became liable for tax again, and depending on the amount you've got saved, you may not be able to re-invest it into an ISA. Then there's the possibility that you breach the £1,000 interest threshold, and if rates were to rise – it seems unlikely at present, but it could happen in years to come – only a small portion of your savings could end up being tax-free.

However, this isn't the case with an ISA. Funds held in these accounts remain tax-free for life, regardless of what happens to interest rates, and with up to £20,000 able to be deposited per year, your tax-free savings pot could quickly add up. ISAs aren't dependent on tax status, either, unlike with the PSA where only basic rate taxpayers will receive the £1,000 tax-free allowance. Higher rate taxpayers only get a £500 allowance, while additional rate taxpayers don't get any, but the ISA doesn't discriminate.

So, ISA rates may be faltering, but they're still a worthwhile savings vehicle for the long-term. Check out our ISA best buys to make the most of things.

Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.