A cash ISA, or individual savings account, is a canny way of saving money without have to pay tax on the interest. Basic rate taxpayers lose 20% of their interest on regular savings accounts in tax, and higher rate taxpayers lose 40%. That’s £20 or £40 from every £100.
With interest rates on ISAs hovering around the 1% mark, if you have £1,000 in your pot you’ll only be looking at £10 interest. If your money wasn’t in an ISA, you’d stand to lose £2 in interest. £2 isn’t a lot of money in the grand scheme of things but why should you let the taxman line his coffers anymore than he currently does? Plus, that £2 is based on you having £1,000 of savings. Once you start to add to this, the tax you have to pay only increases.
If you’re lucky to have £30,000 in savings (perhaps you’re saving for a house deposit) that 1% interest turns into £300 and the tax owed becomes £60. Again, this is for basic rate taxpayers. If you’re a higher rate taxpayer, you can double your tax bill.
So how does it all work?
All UK residents aged over 16 get a tax-free ISA allowance, which is the amount you are allowed to save in your ISA in one tax year. The tax year runs from 6th April to 5th April the following year.
This tax year, the individual ISA allowance is £15,000, and from 6th April 2015 that’s increasing to £15,240. There are both cash ISAs and stocks and shares ISAs. We’re just going to talk about cash ISAs here.
The allowance doesn’t roll over so if you don’t use your whole allowance in one tax year, you lose it. This allowance is also the maximum you can pay in during the course of the year and it doesn’t reset if you withdraw any funds. So if you pay £7,000 in over the year but withdraw £3,000 to buy a new car, you still only have £8,000 allowance remaining that tax year.
Why open a cash ISA?
The interest rates on savings accounts right now are pretty dire. Being able to keep 100% of your interest using your ISA effectively means you can earn more interest than in any other savings account. As a basic rate taxpayer, you’d have to find a regular savings account that pays 2.5% interest, which isn’t very likely. If you do see an account offering tempting interest rates, check they’re not just “teaser” introductory rates that fall off a cliff after the first year.
You are entitled to use your entire allowance each year and continue to benefit from the tax benefits and interest earned until you withdraw the cash. If you squirrel away money every month and can resist touching it you could accrue a huge savings pot and not have to pay a penny of tax on it. Kerching!
Cash ISA – key facts
- There are lots of different cash ISAs to choose from including:
- Instant access, which is ideal if you need to be able to get hold of your money at the drop of a hat
- Regular savings that require you to save each month
- Fixed rate means that the tax-free interest rate is fixed for a certain amount of time. This is perfect if you’re saving a lump-sum as you’ll know how much interest you’re going to earn and can easily compare ISA providers.
- Many cash ISAs can be opened with as little as £1.
- Restricting the access to your money can give you better interest rates, for example some accounts with require 30 days’ notice that you want to withdraw some cash.
- ISAs are offered by banks, building societies, credit unions, the Post Office and others. Don’t feel you have to open your ISA at the same bank as where you hold your current account. Although some banks and building societies do offer preferential rates for their existing customers. Shop around for the best deal.
- You can only pay into one cash ISA per tax year
- It’s not possible to have a joint ISA. Individuals have their own allowance, which can’t be pooled.
- If you have to fill in a tax return, you don’t need to declare any ISA interest.
Should I have an ISA?
The simple answer is, why not? If you have any kind of savings account, it’s not likely you’ll be earning much interest on it. Moving that cash into an ISA means you can grow your savings without losing a penny to the taxman.
If you’re the kind of girl who puts money is their savings account every so often, perhaps for a ‘rainy day’, but then finds that it’s pretty rainy quite often (like me!), an ISA probably isn’t going to do much for you. You’re only really going to benefit if you’d normally be paying tax on your interest and you can only earn interest if you have money in your savings account. 1% of nothing is a big fat nothing.
If on the other hand you’re more disciplined with your money, an ISA could be ideal for you.
What are you like at saving? Do you have any tips to share? Leave me a comment below!