What is an ISA and why are they important?

An ISA – or Individual Savings Account – is a tax-free savings account.  If you are a resident in the UK or a Crown servant (for example a diplomatic or overseas civil service Crown servant) and spouse or civil partner, you can squirrel away £20,000 a year into a tax efficient savings or investment vehicle – and it’s arguably never been more important to make use of all the tax allowances available to us where possible.

Research by the campaign group TaxPayers’ Alliance has found that the number of people now paying income tax has surged by 4.5 million in the last 14 years – there are now 35.5 million paying income tax, compared to 31 million in 2010. But most of these have become new taxpayers over the last three years.

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The plethora of stealth taxes, such as the ongoing freeze to our Personal Allowances, means that 2.5 million have become taxpayers since these stealth taxes came into force in 2021 – and more than a million people have been dragged into the higher rate tax bracket.

What’s been happening to ISA rates?

As savings rates started to rise in 2022, initially ISAs were largely ignored – instead there was a pretty fierce battle in the fixed rate bond tables. As a result, the gap between the top paying bonds and equivalent ISAs increased to more than 40% - far more than the tax benefit of putting money into these tax-free savings accounts. For example, in August 2021 the top 1-year bond was paying 1.38% before the deduction of tax – 1.10% if basic rate tax was deducted and 0.83% if higher rate 40% tax was accounted for. The top ISA on the other hand was paying just 0.80% - less than the rate even a higher rate taxpayer could have earned on the bond.

The good news is that as savings rates have risen, people are utilising their Personal Savings Allowance (PSA) with smaller and smaller deposits.

The PSA allows basic rate taxpayers to pay no tax on up to £1,000 in savings interest, whilst higher rate tax payers can earn £500 a year tax free (this is interest earned outside of an ISA – interest earned inside an ISA is always tax free, regardless of the amount). Additional rate tax payers don’t have a PSA at all.

As a result of rising interest rate savers began turning back to ISAs to shelter their cash, and that has generated some competition between providers, closing the gap between the top rates of bonds versus ISAs, significantly. Today, while the top 1 year fixed rate bond is paying 5.21%, the top ISA is paying 5%, so anyone paying tax on their savings would earn more by putting their money into the ISA.

What changes are coming?

One of the barriers that some savers find when deciding whether to open an ISA or not is the complexity. There are too many rules and regulations. So, it was good news that in the 2023 Autumn Statement last November, some of these rules are to be simplified with effect from the new tax year. Unfortunately, the annual allowance will remain at £20,000 for the eighth year in a row, but some of the complex rules have been removed, which may help people to navigate the ISA maze a little more easily.

The changes that will affect cash ISAs are as follows:

• Allowing multiple ISA subscriptions: People will be allowed to open and pay into multiple ISAs of the same type in a single tax year – as long as they do not exceed the overall ISA allowance of £20,000. Currently people can only pay into one of each type of ISA every tax year, unless the ISAs are what are known as Portfolio ISAs. Where this could be an issue was if you had had funded a fixed term ISA with less than the full allowance and then wanted to top up at a later date. As you are normally only given a short window to fund a fixed term account, you would have needed to open another ISA, which in the majority of cases, is not allowed. So this really is a good move.
• Partial transfers allowed: Partial transfers of ISA funds in-year will be allowed, rather than being forced to transfer the whole amount of your current tax year ISA. Why was it previously a rule that while you could make partial transfers of old ISAs, you’d have to transfer the current tax year’s ISA entirely?
• Increase the age for opening a cash ISAs from 16 to 18 years of age: The minimum opening age for adult ISAs will be 18. This doesn’t appear to be such good news for younger savers, as at the moment a 16-year-old can open an adult cash ISA.

As the ISA season is getting into full swing and with rates continuing to rise, make sure you don’t miss out on the opportunity to protect some of your savings from the taxman. Please see Savings Champion website for the best rates on the market.

If you’d like to speak to an independent financial adviser about your own personal savings, please get in touch. 

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate tax advice.