Cash ISA eclipse
A change to taxes on savings puts Cash ISAs in the shade.
While the March Budget made Cash ISAs more flexible, next year’s introduction of the new Personal Savings Allowance abolishes tax on savings for 95%¹ of savers. Does that make the Cash ISA completely redundant?
There have been two Budgets this year. The latest, in July, gave savers the freedom to withdraw and then replace money in their Cash ISAs in the same tax year without it counting towards that year’s annual subscription limit. Until now, any money taken out of an ISA promptly lost its tax-free status and couldn’t be replaced. The ISA allowance for the current tax year is £15,240. A landmark change in the earlier March Budget, however, may make the Cash ISA pointless for most savers.
From April 2016, anyone with taxable income of less than £16,800 won’t have to pay any tax on interest earned from their savings. From the same date, banks and building societies will stop automatically taking 20% in Income Tax from the interest earned on non-ISA savings. Instead, these earnings must be declared, and will be taxed via self-assessment through the introduction of a new ‘digital tax account’ early next year. But the introduction of the tax-free Personal Savings Allowance means that basic rate taxpayers won’t pay tax on their first £1,000 of interest. That falls to £500 for higher rate taxpayers, while additional rate taxpayers get no benefit. The Chancellor said that this would scrap savings taxes for 17 million people.
Some observers have called this the “death knell” for Cash ISAs. When ISAs were first launched back in the late 1990s, cash savers could earn upwards of 7% tax-free. But with interest rates as low as they are now, the returns from deposit-based savings are negligible. The Personal Savings Allowance dwarfs anything that might be earned in the early years of a Cash ISA.
The average instant-access Cash ISA rate is a mere 1.01%. Anyone who deposits the maximum annual sum of £15,240 would earn interest of only £153² in the first year, well short of the new £1,000 Personal Savings Allowance. If and when interest rates go up, the gap would narrow, but savings rates would need to go well over 6% for Cash ISAs to pull ahead. Bank of England governor Mark Carney recently suggested that base rates might get back to 2% over the next three years.
Indeed, with the Personal Savings Allowance, anyone paying basic rate tax would have to put £62,500 into the best-buy easy-access savings account³ before paying any tax on the interest. With the advent of the Personal Savings Allowance, the Cash ISA may finally have had its day.
Today, UK investors continue to use their valuable ISA allowance to invest in cash (nearly half of all ISAs subscribed to during 2014 were Cash ISAs). Yet history shows that the optimum way to generate decent long-term returns is by investing in those assets able to provide inflation-beating returns, such as equities. In our opinion, this represents the most sensible long-term strategy.
² Bank of England, May 2015
³ savingschampion.co.uk, 17 July 2015, BM Savings 1.6% gross
The value of an ISA with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested. An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.