As a new tax year approaches, savers may well be getting ready to invest in a new cash ISA for 2017, particularly as average ISA rates have begun to edge up. However, our latest research shows that, although saving into an ISA will always be worthwhile, you may want to consider maximising your Personal Savings Allowance (PSA) for even bigger returns.
Since April 2016, savers have had an individual Personal Savings Allowance that lets them earn a portion of savings income or interest completely tax-free, with basic rate (20%) tax payers given a £1,000 allowance and higher rate (40%) taxpayers getting £500. This momentous change is estimated to have brought 95% of taxpayers out of savings tax altogether, which means that most taxpayers should no longer be paying tax on their savings interest.
Our data suggests that it's worked well, and savers could now actually earn far more in interest by maxing out their PSA instead of their ISA. Indeed, as interest rates are poor compared to years gone by, you'd need a significant sum invested to breach the allowance; and as the table below shows, if you were to invest £20,000 (which is the new 2017/18 ISA allowance) in the best ISA instead of the best non-ISA, you could actually be worse off, yet neither return will take you over the PSA limit.
|Non-ISA||Return after 1 year on £20,000||ISA||Return after 1 year on £20,000||Difference over 1 year|
|Best easy access||Yorkshire BS - 1.15%||£230.00||Coventry BS - 1.05%||£210.00||-£20|
|Best one-year fixed||Atom Bank - 1.60%||£320.00||Bank of Cyprus UK - 1.10%||£220.00||-£100|
|Best two-year fixed||Atom Bank - 1.70%||£340.00||Principality BS - 1.26%||£252.00||-£88|
|Best five-year fixed||Milestone Savings* - 2.30%||£460.00||Paragon Bank - 1.75%||£350.00||-£110|
|*Operates under Islamic finance principles; the rates displayed represent the expected profit rate.|
"It's been almost a full year since the Government introduced the Personal Savings Allowance to enable savers to earn more savings interest tax-free, and while this has been an ingenious way to encourage consumers to save, it has also had a big impact on the appeal of ISAs," said Rachel Springall, finance expert at Moneyfacts.co.uk.
"ISAs overall have been struggling to keep up with the more desirable returns that standard savings accounts have on offer. In fact, only Coventry Building Society's easy access ISA attempts to pay anywhere close to a non-ISA Best Buy equivalent, with a difference of 0.10%."
Both sectors of the market have suffered from falling rates over the last year, with average ISA rates hit particularly hard. For example, a year ago the average one-year fixed ISA paid 1.31%, as did the non-ISA equivalent, but since then the average one-year ISA rate has fallen by 0.43%, whereas the non-ISA rate has fallen by a lesser 0.34%.
"Despite the allowances taxpayers receive, savers have still had to endure years of low interest rates, largely due to Government lending initiatives and the Bank of England's 0.25% rate cut last year," added Rachel. "All this combined has forced savings rates to plummet, making it vital for savers to keep on top of the Best Buys and to try not to be too discouraged when it comes to saving for the future."
It's worth noting that, although ISAs currently pay less than their non-ISA counterparts, you still shouldn't overlook them. After all, ISAs have the benefit of keeping your savings tax-free for life, regardless of how big a pot you hold, so if you've been saving into an ISA for several years, you could already have a sizeable sum that would breach the PSA. There's nothing to stop you from adding to this to boost your tax-efficiency even more.
It's worth thinking about the future, too. Rates may be low now, but if they were to rise in a few years' time, you'd be able to save far less before you breached your personal savings allowance - something that won't be an issue with an ISA, where all you have to worry about is keeping within your annual ISA allowance. There's also no telling how long PSA rules will last, so if the initiative is withdrawn in the future, your savings would become taxable. Again, this isn't an issue for an ISA, so a mix and match approach - a traditional savings account as well as an ISA - could be ideal.
ISAs allow you to think about the long-term and can be a great way to save for the future, so with the new tax year almost upon us, they're still worth considering. You may want to transfer your current cash ISA if you're not getting the best rates, or you may simply want to start thinking about your cash ISA for 2017, in which case our ISA Best Buys would be a great place to start.
If you're comfortable with risk, consider stocks & shares ISAs, as these could outperform both forms of cash savings accounts.
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.