ISAs still behind fixed rate bonds

While the ISA market has been weakening ever since the personal savings allowance (PSA) came into force – which allows basic rate taxpayers to earn £1,000 in interest tax-free every year since 2016 – the latest base rate rise doesn't appear to have helped matters. New data from Moneyfacts.co.uk shows that fixed rate ISAs are still falling behind fixed bond rates, in terms of both averages and the Best Buys.

"It is little surprise to see that cash ISAs are being ignored by many savers," said Rachel Springall, finance expert at Moneyfacts.co.uk. Aside from the PSA, "savers have also faced the blight of Government lending initiatives, which decimated the savings market and forced interest rates to plummet. Before these interventions, the rate gap was much smaller."

To make matters worse, research reveals that while savers can earn more than 2% interest on a one-year fixed rate bond, there is not a single fixed rate ISA that pays as much. It's little wonder then that the number of people investing in ISAs has fallen to an 18-year low, according to the HMRC.

And it's not only the lack of interest rate increases that are hurting people's chances of finding a decent ISA deal, as Rachel also found that very few new providers are entering the ISA market now. "There are 98 fixed rate bond providers in the market but only 56 fixed rate ISA providers, so there is a lot less choice out there for savers looking to utilise their annual £20,000 ISA allowance," she said.

However, those who already have a decent amount saved away in a cash ISA may not want to switch to a fixed rate bond just yet. Any money taken out of an ISA would become liable for taxation, and if the PSA were to disappear, they'd have to start putting away the maximum ISA allowance all over again to get back their big tax-free savings pot.

"It remains the case that savers will need to switch their ISAs frequently to get the best rates on the market, but it's likely that they will still get less of a return than if they had the money invested in a top fixed rate bond," Rachel concluded. "For example, on a five-year fixed deal, there is a 0.40% difference between the best rate fixed bond and its ISA equivalent.

"Clearly, something needs to be done to get savers turning to ISAs again. If the PSA was ever abolished to bring in more tax from savers, then ISAs may shine brightly again in terms of their tax-free wrapper, but that doesn't automatically mean rates will shoot up in the process."

What next?

If you've already got a decent pot of money in an ISA, you'll want to keep on top of the cash ISA Best Buys to make the most of your savings. If you're looking for the best fixed rate deal overall, however, you'll want to check the top fixed rate bonds.