The great Cash ISA dilemma

by Alison Hunt on 31 July 2009  |  8 comments
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With rates abominably low, is it still worth stashing your cash in a Cash ISA - or should you put your money in a normal savings account, with a better rate?

It's hard to believe but ISAs have been around for an astonishing 10 years now. Launched in 1999, they were the government's weapon to persuade all of us to save. And to sweeten the deal, the interest earned is paid, tax free.

So far we've squirreled more than £220bn of our hard earned money into Cash ISAs since their launch, and last year saw the long-awaited rise of the maximum annual limit from £3k to £3,600.

Cash Isa limit to increase to £5,100

What's more, this limit is set to increase again, to £5,100 in April 2010 for anyone aged 16-49. Those aged over-50 can take advantage even sooner, as their ISA limit is set to rise on 6 October 2009.

Beware the rules..

Isas are a bit confusing. For a start you can, at present, only stash £3,600 into a Cash ISA each financial year - and should you withdraw any of this sum it cannot be replaced.

Say you stash £3,600 in a Cash ISA and then, a few months later, withdraw £1,000. Even though you've only got £2,600 left in your ISA, you won't be allowed to deposit any more money. You cannot replace the £1,000 you have withdrawn.

And while you can move your cash to another provider, you must ensure you ask your provider to "transfer" it - should you close the account in the hope of reopening another, you will lose the tax benefits.

Great savings tool

But on the plus side, ISAs have always been viewed as a great way to save due to the tax relief.

After all, a higher rate tax payer with an account paying 5% will actually keep all of this interest, as opposed to earning just 3% in a bog-standard savings account after tax. This can be worth hundreds of pounds each year. And the best bit is you don't need to declare your cash ISA on your tax return.

Non-taxpayers

If you don't use your ISA allowance each year it's lost forever. That's why I think even non-taxpayers should consider using it up. After all, who knows what the future will bring - isn't it better to shield your cash from the tax man just in case?

Times have changed

But sadly, the credit crunch has shown us that things can change very quickly. Cash ISA rates have fallen dramatically in recent months, meaning most now pay less than standard savings accounts, even after taking tax into account!

So are Cash ISAs still the best place for your cash?

Example

For example, save less than £9k in the NatWest Cash ISA and your money will earn a very disappointing 0.6%AER.

Compare this to the current top instant access savings account - Alliance & Leicester's (A&L) Online saver, paying 3.15%AER. That's over five times more interest!

Even after tax, a basic rate taxpayer would still be earning 2.52%AER and a higher rate taxpayer 1.89%AER in the A&L account. So stashing £6k in the ISA would mean earning just £36, as opposed to £151.20 and £113.40, respectively.

Is it really worth troubling yourself with all the rules and regulations of ISAs when you'll earn less interest?

Not all doom and gloom

Well, maybe. While most Cash ISAs do pay pretty dismal rates, there are a few accounts still paying half-decent sums, you just need to do a bit of research to find them (and be prepared to tie your money up for a while).

And the building societies seem keenest to get hold of our cash.

If you have £1k or more, Manchester BS has two options. The Premier Instant ISA pays 2.26%AER with instant access. If you don't mind tying up your cash for a bit the Premier ISA 45 pays 3.26%AER (including a 0.8% bonus) and requires 45 days notice.

Principality BS has a 3-year fixed rate ISA paying 4.2%AER on savings of £1+. And Nationwide BS has a 5-year fixed rate Isa bond paying 4.5%AER on £1+.

Still worth it?

So as you can see it can still be worthwhile using your ISA allowance and planning for the future. After all, interest rates will rise again, of that we can be sure, and they'll hopefully take the Cash ISA rates with them. Sheltering your hard earned cash from the taxman can be time well spent.

However, personally, I wouldn't want to tie my money up for five years at the moment. I'd prefer to earn a bit less interest in a more easily accessible account, so the cash can be moved quickly when better deals become available.

This will mean accepting a lower rate. But I still think it's worth keeping your cash within an ISA, to ensure that - no matter what happens in the future - your savings will always be able to earn interest, tax-free.

FSCS guarantee

Finally, when choosing a home for your Cash ISA, don't forget to take into account the Financial Services Compensation Scheme (FSCS) which protects the first £50k we have saved with any financial institution.

If the total sum of your ISA and any savings is more than this figure, make sure you don't pick the same institution for both in order to spread your risk.

Find a better Cash ISA at lovemoney.com

More: An innovative way to earn 8.2% on your cash | Get a better fixed rate on your savings