Cash ISAs are one of the most popular types of savings account available in the UK, thanks in no small part to the tax incentives they offer. But is a cash ISA the best option for you? What alternatives are available, and how do you choose the best product for your needs, circumstances and investment preferences?
We answer these questions and more in our comprehensive guide to cash ISAs…
A cash ISA (Individual Savings Account) is a type of savings account that lets you earn interest free of income tax. To be eligible for one, you must be a UK resident (for tax purposes) over the age of 16. Junior ISAs are available for anyone below this age, although these must be opened on a child’s behalf by a parent or legal guardian.
How do they work?
You can open one cash ISA per tax year. Any savings you put in are protected but interest rates are typically low compared to other investment products, such as a stocks and shares ISA. Some cash ISAs come with an introductory rates period where the interest is higher, before reverting to a variable interest rate.
Variable rate products are usually instant-access accounts where you can withdraw funds freely, but if you tied yourself into a fixed rate, there might be penalties to pay if you make a withdrawal during the initial period. There is also a possibility that you will lose out on the higher introductory rate if you withdraw cash early.
You can contribute up to £20,000 in savings per annum, in line with the cash ISA allowance for 2020/21. If you withdraw money from a standard cash ISA account, this limit will not reset. So, if you had hit your allowance limit and took £2,000 out during the current tax year, you would have to wait until the following tax year to top up those funds.
There are products known as flexible ISAs which are exempt from this rule. If you have one of these accounts, you can top up any funds you take out to remain within the £20,000 cap.
Although you can only open one cash ISA per tax year, you could start up a stocks and shares ISA, Lifetime ISA and an innovative finance ISA during the same fiscal period. The £20,000 cap still applies but you could spread it over the multiple types of ISA.
You could generate more interest in your ISA by transferring your cash-based account to an investment-linked scheme. Be sure to speak to a financial advisor before doing this, as the level of risk is typically higher for stocks and shares ISAs.
The experts we work with can help you decide whether transferring your cash ISA elsewhere is a good idea for you, based on your circumstances, goals and appetite for risk.
What you do with the funds you save up in a cash ISA is entirely up to you. You’re free to withdraw money from your account, but if you’re in a fixed rate deal, this could mean having to pay a fee or losing out on the higher interest rate of the introductory period.
Cash ISAs are also transferrable. You can move your account from one provider to another if you find one offering a higher interest rate, or even move your funds over to another type of ISA, such as a stocks and shares-based account, if that is a better fit for your needs and appetite for risk. You should speak to an independent financial advisor before making a transfer as their whole-of-market knowledge will help you make the right decision.
Whether you should choose a cash ISA or another type of savings account may ultimately come down to the reason you’re saving up. For instance, if you’re putting money away for your retirement or to buy a property, depending on your age, a lifetime ISA may be a better alternative.
Those with a higher appetite for risk, meanwhile, may wish to discuss the possibility of taking out an investment ISA with a financial advisor, instead of going ahead with a cash ISA.
Most experts would recommend the following as potential alternatives to cash ISAs…
- Stocks and shares ISAs: These are often floated as a cash ISA alternative because the potential returns on investment-linked accounts are much higher than they are for cash ISAs. However, you should keep in mind that the value of your assets could fall as well as rise, so it’s important to speak to an expert before investing.
- Standard savings accounts: Since you can earn the first £1,000 of interest on non-Isa savings tax-free (£500 for higher-rate taxpayers), regular savings accounts have become a viable alternative to cash ISAs. Although ISAs can safeguard your savings if interest rates were to spike, it’s worth asking a financial advisor to compare the rates for cash ISA deals with savings account across the whole of the market for you.
- Lifetime ISAs: These may be a better option if the reason you are saving is to buy a property or build up a retirement fund to supplement your pension investments.
- Premium bonds: These don’t offer interest per se but can generate returns via a prize draw. You can invest up to £50,000 and there’s no risk to the money you put in. Every £1 invested is assigned a bond number and this is entered into a monthly prize draw where you could win anything between £25 and the jackpot of £1 million.
For many savers, there are higher returns on offer with some of these alternatives as well as added risk. To choose the right investment product for your needs, circumstances and requirements, speak to an independent financial advisor who can lay out the pros and cons of each choice. Make an enquiry and we’ll introduce you to one for free.
Find the answers to the questions we hear most often about cash ISAs…
Can you lose money?
There is no risk to the savings you put into a cash ISA but you could be missing out on higher returns by choosing one over a product type with a superior rate of return, such as an investment ISA. It’s also worth considering that you could miss out on interest if the current rates are less than the rate of inflation.
Speak to an advisor to find out whether investment ISAs are a suitable alternative for you, based on your appetite for risk and the latest stock market conditions and forecasts.
Can I open an account in joint names?
No, cash ISAs cannot be held in joint names. It is, however, possible to open a regular savings account in joint names and potentially earn a similar amount of tax-free interest.
What types of cash ISA are available?
Some cash ISAs come with a fixed rate (usually between one and five years) during which there are higher interest rates on offer, while others are variable rate from the day you take them out. Variable rate cash ISAs typically come with lower interest rates but it’s usually possible to withdraw cash without incurring any additional fees.
Another sub-category of cash ISAs that you should be aware of are flexible cash ISAs. With these products, you can replace any funds you withdraw during the current tax year to keep your account topped up, up to the 2020/21 annual contribution limit of £20,000.
Other types of ISA can be cash-based as well as investment-linked, such as lifetime ISAs and junior ISAs.
How do I find the best variable rate cash ISAs?
You can compare the interest rates on offer yourself or speak to an independent financial advisor who has access to the entire market. If you’re using an advisor, it may be worth asking them to check how the interest rates compare with returns you could get on an investment ISAs. They can weigh up whether the potential returns are worth the added risk, based on your circumstances and financial goals.
Can I open one for my grandchildren?
No. You can’t open a standard cash ISA on behalf of another person. That said, it would be possible to open a cash-based junior ISA for your grandchildren if you are their legal guardian. If you aren’t their legal guardian, you can still pay into a junior ISA that was opened in your grandchildren’s name by one of their parents/guardians.
When did cash ISAs start?
Cash ISAs were introduced in April 1999 when they came in to replace Tax-Exempt Special Savings Accounts (TESSAs). Investments ISAs debuted at the same time as a replacement for personal equity plans (PEPs).
Are there low-risk non-cash ISAs?
There will usually be an increased risk if you are putting your money in an investment ISA because, unlike with a cash ISA, the value of your assets could fall as well as rise. However, many investment providers offer stocks and shares ISAs where the underlying investments are specifically designed to be low-risk.
The best way to find a suitable low-risk ISA which isn’t cash-based is to speak to an independent advisor. They can help you with your investment decisions and make sure your money is as safeguarded as possible.
If you’re thinking of taking out a cash ISA, it’s always worth consulting with an independent financial advisor first to make sure this is the right option for your needs and circumstances. It could well be the case that an investment-based product offers potentially higher returns with a level of risk that you’re perfectly comfortable with.
And even if you are dead set on a cash-based ISA, speaking to an advisor will ensure you end up with the best interest rates on the market. So call 0808 189 0463 or make an enquiry and we’ll introduce you to the right expert for a free, no-obligation chat.