This week saw the start of a new tax year, which means that savers can once again deposit up to £20,000 into an ISA tax-free for the 2021/22 tax year. The renewal of the tax-free ISA allowance means that many savers will be looking at the ISA charts to see what best rates are available to ensure that they earn the best interest possible on their ISA savings. But although rates within the fixed ISA charts regularly beat those being offered in the easy access ISA chart, savers should also think long-term when it comes to their ISA savings and, as a result, a fixed rate ISA may not always be the best option despite offering better rates.
Here we look at the factors savers should consider when choosing an ISA and whether a fixed rate or easy access ISA is the best option.
Savers looking for the highest rate in the ISA charts will usually need to look for a long-term fixed rate ISA. Indeed, the average ISA rates on the 1 March 2020 showed that longer-term ISAs offered, on average, a rate of 0.59%, which compares to the average one year fixed ISA rate on the same day standing at 0.38%. Meanwhile, the average easy access ISA rate on this day was just 0.23%.
It’s not just average rates that see fixed rate ISAs pay higher rates than easy access ISAs, but the best rates available in the ISA charts show this as well. For example, looking at the chart today, the top rate overall comes from a seven-year fixed rate ISA paying 1.25% AER, which compares to just 0.45% AER currently being offered on the top-paying easy access ISA. Saying this, the top rate on a fixed ISA on a one-year term pays just marginally higher than the top easy access ISA rate at just 0.49% AER.
Clearly, savers looking at rate overall would be better off choosing a long-term fixed rate ISA, but with the current top long-term fixed rate being offered at 1.25%, this may not be the best choice for savers in the current climate.
At the start of the pandemic last year, the Bank of England cut base rate to a historic low of 0.10% to help manage the impact the pandemic would have on the economy. Although the cut in base rate contributed to rates falling across the charts, often easy access ISAs are impacted the quickest by base rate cuts. This is because easy access ISAs are variable rates, meaning that the rates on these ISAs can be increased or decreased by the provider; with a fixed rate ISA however, the rate will stay the same for the remainder of the term no matter what happens to the base rate. This means that if base rate is cut further, and there is still the possibility of negative interest rates, then easy access ISAs could see rates fall further, but if the Bank of England decides to increase base rate, an easy access ISA could pay more than that which is currently being offered on the top-paying one year fixed rate ISA.
The last 12 months have shown that it is impossible to predict what will happen in the future, but in the current climate it seems that it is unlikely that base rate will be increased by a significant amount in the near future, which makes fixed rate ISAs again seem a better option for savers. But there is the real possibility that inflation will rise over the coming months, which could make locking into a long-term fixed rate ISA result in savings being eroded over time.
The inflation figures for February saw the Consumer Prices Index fall to 0.40% during the month, which if inflation stayed at this rate or lower would mean that all the current top rates in the fixed ISA charts are able to beat inflation. Unfortunately for savers, inflation is expected to rise this year and could even become higher than the Bank of England’s target inflation figure of 2%. If inflation does rise as expected and reaches the target rate of 2%, it would mean that savers who had locked into a fixed rate ISA will see inflation eroding their savings over time. Even the best rate in the fixed rate ISA chart of 1.25% over a seven-year term is significantly lower than the Bank of England’s target inflation of 2%.
Although the rates being offered on fixed ISAs are more attractive than easy access ISAs, when taking into consideration inflation, savers may be better off opting for an easy access ISA over a fixed ISA. Saying this, savers should consider the reason why they are saving. Those saving for a deposit for their first home, for example, may want to consider a Lifetime ISA, which includes a yearly 25% Government bonus that could significantly boost their savings. Meanwhile, long-term savers who have the willingness and ability to risk their money may want to consider a stocks and shares ISA.
For those saving for a rainy day, an easy access ISA may prove to be the best option as these ISAs allow savers to withdraw their funds quickly, but savers should be aware that some easy access ISAs do come with withdrawal restrictions and they should check these before opening the ISA.
Savers who are concerned about the possibility of negative interest rates and who want the security of a fixed rate ISA, may want to consider a shorter-term fixed ISA, for example a one year fixed ISA. Although the top-paying one year fixed ISA rate currently available in the chart is not much higher than the top-paying easy access ISA rate, there is the guarantee that this rate will not fall during the one-year term and, although the savings will be impacted if inflation rises, the impact may not be as severe compared to locking money into a long term ISA.
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