How to find the best Cash Isa rates and make use of your annual tax allowance

MILLIONS of Brits are saving money tax-free in Cash Isas.

Rather than leaving your hard-earned money in your current account, it could be earning interest tax-free – here is how to find the best Cash Isa rates.

What is a Cash Isa?

Each tax year, everyone over the age of 16 in the UK gets an Isa (Individual Savings Account) allowance, which lets them save money tax-free.

One option is to put your money into a Cash Isa.

Around 8.4 million people contributed to a Cash Isa in the 2018/19 tax year, according to HMRC.

This means they can earn interest on their savings in a bank, building society or other financial provider, without any tax deducted.

Savings kept in an Isa will continue to earn interest tax-free until the money is withdrawn from the account.

A Cash Isa is just one way of saving tax-free.

Money can be put in a Stocks and Shares Isa from age 18 to earn interest tax-free from investing in the stockmarket or you can back peer-to-peer loans through an Innovative Finance Isa.

There is also a Lifetime Isa that lets anyone age 18 to 39 save money and earn a government bonus that can be put towards a house deposit or your retirement savings.

These products all fall under the same annual Isa allowance.

Separately, parents can save money tax-free for their children using a Junior Isa, which has a cash and stocks and shares version.

The Junior Isa allowance is separate to the main Isa allowance and is currently £9,000.

How much can I put in a Cash Isa in 2021?

Savers have to use their Isa allowance within each tax year, which runs from April 6 to April 5.

It cannot be rolled over so you must use it or lose it before the tax year ends.

The maximum amount you can put away for the 2020/21 tax year is £20,000.

This has remained at the same level since 2017/18 and is a lot more generous than previous years.

The Cash Isa limit was £3,000 when the product was first launched in 1999 and has gradually increased as the government wanted to encourage Brits to save more.

Who can open an Isa?

Anyone over the age of 16 can open a Cash Isa and you must be a UK resident.

You can only open an Isa in your own name and cannot hold it jointly or for someone else.

This is slightly different to a Junior Isa which lets you open a tax-free savings account on behalf of your child.

What are the advantages of an Isa?

An Isa can help you try to beat inflation and avoid income tax charges.

It also helps you boost your savings if you are putting money away for a big event such as a mortgage deposit, new car or your summer holiday.

Cash sitting in your bank account often doesn't earn any interest and its value risks being eaten by inflation, known as the cost of living.

If the inflation rate – which represents the cost of your bills such as your rent, mortgage, clothing or grocery shopping – rises faster than interest earned on your cash, then you are effectively losing money.

One option is to put money into a savings account and aim for an interest rate above the inflation level.

This isn't always easy, especially with the Bank of England base rate at record lows as providers will use this as an indicator for how to price their ISAs.

But there is also the risk of income tax charges.

Everyone can earn up to £12,570 from 2021/22 before tax is owed.

Most of this will be covered by your salary so if you earn interest on a savings account outside of an Isa you could be charged tax on the returns.

You don't need to worry about income tax with an ISA.

Any interest on your savings remain tax-free as long as they remain in an ISA.

Is it worth getting an Isa in 2021?

For many years, Isas were the number one option for savers, as you can shelter your hard-earned cash away from the hands of the tax-man.

But all that changed in April 2016 when the government introduced a big shake-up to something called the Personal Savings Allowance (PSA).

Under the scheme, basic rate taxpayers can now earn £1,000 in interest a year tax-free – in whatever account they're saving in.

While if you're a higher-rate taxpayer you earn up to £500 tax-free.

At the time, the government estimated the change meant the vast majority – around 95% of adults – now no longer pay any tax on their savings.

With savings rates at record lows, you would need a lot of money and a high rate of interest to earn more than £1,000 a year.

This may make an Isa appear less useful.

For example, if you found an easy access rate to match inflation of 0.4%, you would need to save up to around £255,000 before earning £1,000 of interest to go beyond the PSA.

An ISA can still be effective though, especially for high earners.

A higher rate taxpayer would go beyond the PSA once they have saved more than £125,000 in the same savings account.

There is nothing to stop you using both the PSA and an ISA, especially if you have a large lump sum you want to earn interest on.

Additionally, rates can change all the time and may increase so having your money in an account that never charges tax could be more effective in the long-run.

Can I have more than one Isa?

Your Isa is split into new contributions and transfers from older products opened in previous tax periods.

There is new money that you can contribute each year up to your £20,000 allowance, plus you can also transfer money sitting in old Isas from previous years.

Any new money can only be contributed into one type of each Isa account in a single tax year.

This means you can only open and contribute to one cash Isa, one stocks and shares Isa and one Lifetime and Innovative Finance Isa during the 2021/22 tax year.

You can still keep Isa money in old accounts from previous years so you could have several old Cash Isa accounts and one new one each tax year that you make contributions into.

Additionally, you can transfer old Isa money to a newly opened product on top of your new contributions. It may be worth doing this if the interest rate is better and if your older deal has been cut.

Isa transfers are treated separately to new money as it is funds that have already been used under your allowance.

You can often move some or all of your old Isa money.

Not all providers will allow transfers so check with your provider.

Isa transfers can also be made with newly contributed money during the same tax year but you would have to move all your funds and close your account. For example, if you start a Cash Isa in 2021/22 but then find a better deal, you would need to transfer all the money and close the Cash Isa so you can use your allowance somewhere else.

Is my money safe in an ISA?

Cash Isas are offered by banks and building societies which all have to be regulated and provide protection on up to £85,000 of savings under the Financial Services Compensation Scheme.

You can check if your money is protected on the FSCS website.

This means if your provider collapses, your money will still be safe up to the £85,000 limit.

Look out for online scams which may try to tempt you with high rates of interest. Check if a provider is regulated using the Financial Conduct Authority register. 

Scammers may also try to dupe you by pretending to be your bank or building society. Verify information independently such as on their official website or by phoning their customers services number.

What are the different types of Isa?

There are a variety of Cash Isas that you can put your money into.

All will pay a fixed rate of interest but the return will vary depending on the type of product.

Easy access accounts let you earn money tax-free and have the freedom to withdraw your money anytime.

There are also notice accounts that allow limited withdrawals after a certain number of days or may let you take money out once or twice a year.

Remember, once the money is withdrawn it will lose its tax-free status if it isn't put back into an Isa during the same tax year.

The best cash Isa rates are typically paid in a fixed rate product.

This involves locking your money away for a defined period such as one, two or even five years and earning a fixed rate of interest each year.

The rate is usually higher the longer you fix. There are penalties for accessing your money, which may include having to close your account or being charged interest worth anywhere from 60 days to a whole year's worth.

Can I withdraw from a cash ISA whenever I like?

Some Isa products such as an easy access or notice account will let you make withdrawals whenever you want without penalties.

There are charges to withdraw from fixed rate products but some may be flexible.

This means you can make withdrawals and the sum taken won't lose its tax-free status as long as you put the same amount back during the tax year.

For example, if you put £15,000 into a cash Isa and then withdrew £5,000 during the same tax year, that money will stay as part of your allowance so you could top it up to £10,000 and still be within the £20,000 limit as long as the money is replaced before the tax year ends.

Not all Isas have a flexible option so you will need to check with your provider.

Which is better, an Isa or bonds?

An alternative to an Isa is a fixed rate savings account or bond.

Similar to a Cash Isa, you can earn a fixed rate of interest over a defined term and usually need to keep your money locked up for a good few years to earn a decent return.

A savings bond may have different limits to an Isa so you could save more than £20,000 a year but as with an Isa, there may be penalties for early withdrawals.

Savings bonds also have FSCS protection up to £85,000.

The rate on a savings bond will stay the same for an agreed period but, in contrast, the returns on Isa products such as easy access accounts may change from year-to-year.

This could give you more certainty about your returns but any profits are not tax-free like in an Isa.

The government backed National Savings & Investments also offers Premium Bonds.

These don't pay interest but you can save up to £50,000 and each £1 you put in Premium Bonds is an entry into a monthly draw with tax-free cash prizes of up to £1 million.

How do you switch Isa provider?

IF you’re in the market for a new, better paying Isa, there’s one thing you shouldn’t do.

Never withdraw money from your Isa account to put it into your new one – if you do it'll lose its tax free benefits.

Instead you need to follow the simple transfer process.

Make sure that the new account you want to use accepts transfers (not all do) and then fill in the Isa transfer form with the new provider.

It will arrange for your savings to be transferred over, with the process taking no more than 15 working days.

And remember, you can only have one "active" Cash Isa per tax year.

What is the best Cash Isa rate?

Isa rates change all the time.

Deals are priced based on a number of factors such as the Bank of England base rate, competition and demand.

The Bank of England base rate as of March was at a record low of 0.1%. This is one of the main benchmarks banks use to price their products.

When interest rates are low there is less incentive for banks to offer attractive deals as they can access money cheaper elsewhere on the wholesale markets.

A bank or building society may offer a top rate when they are new to the market to gain customers or if they need to attract deposits.

The best Cash Isa rates don't stick around for long as banks will often pull them once they have a certain amount of interest, which can happen quickly when there isn't much competition.

Easy access Cash Isas tend to have lower interest on offer and the best deals usually involve locking your money away for longer using a fixed rate.

This can be risky if you need access to your cash as there may be penalties to pay for early withdrawals.

What are the best fixed rate Cash Isas?

Fixed rate Isas usually offer higher rates than on an easy access product.

In return you have to lock up your money for up to five years in some cases and there may be penalties for withdrawals.

Consider when you need access to the funds before choosing between an easy access or fixed rate Isa.

If you can wait a few years then it may be worth opting for a fixed rate where you could earn more interest.

Don't forget to consider inflation. If you fix for five years now with an inflation-beating rate but the cost of living then rises beyond what you are earning in the Isa, then the value of your money is reduced.

It is a good idea to know what you are saving for and when you will need it so you can decide which type of Isa is best for you.

Your current account provider may offer exclusive cash Isa rates but you should shop around for the best deals.

A comparison website can help you choose the most suitable cash Isa for your needs.

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