Personal savings allowance: Isas vs savings accountsWhich? explores what the new tax break means for Isas
21 March 2016
Which? has analysed the impact of the new personal savings allowance on your savings options.
In the latest edition of Which? Money Magazine, we analysed the rates on offer from 440 savings accounts and Isas, so that savers can compare returns.
Nevertheless, regardless of the deals on offer, we still think there is a case for using your tax-free Isa allowance.
Here, we explore where you can find the best rates, why a cash Isa might still be your best option and a simple savings strategy to boost your Isa returns by hundreds of pounds per year.
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Savings accounts vs Isas: best savings rates
From 6 April 2016, all basic and higher-rate taxpayers will be entitled to a new personal savings allowance.
Basic-rate (20%) taxpayers will be able to earn £1,000 interest tax-free, while higher-rate (40%) taxpayers will be entitled to a £500 allowance.
Banks and building societies will stop automatically taking 20% off returns from standard savings, meaning Isas may no longer be the first port of call for savers.
Throughout January 2016, we analysed 440 instant-access and fixed-rate savings accounts and Isas to uncover the best returns when you take tax out of the equation.
The graph below shows average gross rates, restricted to the top-paying quartile in each category.
We found that the best performers in the instant-access Isa market pay 1.3%, on average, compared with 1% for non-Isas. However, the most competitive three-year bonds pay 2.44%, compared with just 2.1% for Isas. The non-Isa five-year bonds also came out on top, with the top quartile currently paying 2.97% compared with 2.5% for Isas.
The case for Isas
Isas future-proof your savings
We think Isas are still attractive, particularly if you're a higher-rate taxpayer, or if you are at all likely to become a higher-rate taxpayer later on.
Isas become more valuable over time. If you maximise your allowance each year, you can accumulate large sums in a tax-free shelter.
Although the personal savings allowance seems generous while interest rates are so low, what happens when rates start to rise?
If you were currently earning a rate of 1.5% for 12 months, rising to 2.5% in year two, and 4% in year three, a pot of £50,000 would earn £4,100 in interest over three years.
In this scenario, £1,350 of that interest would be liable for tax if you're a basic-rate taxpayer and £2,600 if you're a higher-rate taxpayer (HMRC has said that any tax owed will be collected through the PAYE system).
Couples can inherit each other's Isa allowance
Since April 2015, new rules have meant that spouses and civil partners can pass on their Isa savings tax-free.
The surviving partner is entitled to an 'additional permitted subscription,' or APS allowance. This is a one-off additional Isa allowance equivalent to the value of the deceased person's Isa at the time of death.
Find out more: inheritance Isas - read about the new rules and compare providers
Isas are becoming more flexible (but check your provider)
Separate changes also being introduced on 6 April 2016 will allow you to withdraw funds from an Isa and replace it, without it affecting your annual Isa allowance, as long as you do so in the same tax year.
However, Isa providers are not obliged to offer this facility, so despite the imminent rule change you may not be able to make use of this new flexibility yet.
So far, we've only seen Halifax tell customers that it will offer flexibility on some (but not all) of its cash Isas. Santander has stated that it will NOT offer additional flexibility on its Isa range.
Find out more: lifetime Isas - learn about this upcoming product introduced during last week's Budget
Boost your savings with this simple strategy
Current accounts are also outshining Isas. As with standard savings accounts, current account interest earned up to the new personal savings allowance will be tax-free after 6 April 2016.
Top deals include 5% on balances up to £2,500 at Nationwide. You can also earn 5% on up to £2,000 if you bank with TSB, 4% on £4,000 to £5,000 at Lloyds, and 3% on balances of between £3,000 and £20,000 at Santander.
Meanwhile, even the best-rate instant-access Isa pays just 1.65%, returning a measly £252 if you saved the full Isa allowance of £15,240.
However, in our strategic scenario below, you could boost your return. Simply split your £15,240 allowance between three top-rate current accounts, then deposit it into a cash Isa just before the tax year closes on 5 April 2017.
Our example would boost your annual return by 42%. You can use the same tactic with any number of current accounts offering high interest, as long as you can meet the minimum funding requirements.
Find out more: Best bank accounts for in-credit balances - our tables outline the best rates