Cash ISAs: An Introduction

A cash ISA is a savings account that allows UK residents over the age of 16 to save over £5,000 tax-free every year. Once invested, all cash ISA deposits subsequently remain tax-free. Read on to find out how to make the most of your tax-free savings allowance.

How savings are taxed:

Since 1996, income on savings has been taxed at 20% for the basic rate band, 40% for the higher rate band, and 50% for amounts above £150,000.

If your taxable income is less than your tax-free Personal Allowance, you are entitled to register as a non-taxpayer. Completing an R85 form for each bank where you hold accounts will ensure that no tax is charged on your interest.

If your level of income is just above your tax-free allowance, your savings interest may be subject to a lower tax rate of 10%.

Over £5,000 in tax-free savings? How ISAs work:

For all standard savings accounts and fixed-rate bonds, your gross interest on these accounts is normally taxed as it is processed. Therefore, the return ends up considerably lower than the advertised AER rate.

A cash ISA operates like other savings accounts, but no tax is payable. The rate you see is the rate you get.

Everybody has the same entitlement to tax-free savings. The full allowance is currently £10,680, which will rise to £11,280 in 2012/2013.

Up to half of this amount (£5,340) can be invested in a cash ISA, while the rest can be made up through an investment ISA. A year’s tax-free provision is lost if it is not taken.

If the cash limit (£5,340) was placed in a traditional savings account or fixed-rate bond returning 3%, a basic-rate taxpayer would lose £32.04 in tax on the interest. Building up this ISA over the years could pay handsomely in tax-free interest.

Individuals can only contribute towards one cash ISA in any financial year. However, you can still own more than one ISA, provided that they were opened in separate financial years.

How do interest rates compare?

Like traditional savings accounts, the rate of interest will normally depend on a saver’s willingness to lock cash away for a longer period of time.

The return on instant access cash ISAs is usually lower than fixed-rate ISAs; higher rates are preferred for those who are prepared to commit their tax-free deposits for fixed period from 1 year up to and beyond 5 years.

Fixed-rate ISAs will almost certainly guarantee you better returns. But choose carefully: you are likely to face heavy interest penalties if you withdraw from a fixed-rate ISA during its tenure.

Finding the best cash ISA:

It is wise to watch out for the introductory bonus rates that artificially inflate cash ISAs to make them look more appealing. After the introductory period expires, these can revert to an adversely low level. The average instant-access cash ISA in the UK pays little more than 0.5%.

To benefit from your cash ISA entitlement, it is important that you are aware of how rates compare. If you could benefit by transferring to another ISA provider, you are able to shift all past ISA savings to a new provider.

Transferring £20,000 from a cash ISA paying 0.5% to a new provider offering 3% could generate an additional £500 in tax-free interest over the course of a tax year.

Make the most of your tax-free savings allowance through Which4U.

Additional Notes:

• Junior ISAs, launched in November 2011, differ from standard cash ISAs.


• Tessa-only ISAs (ToISAs), from April 2008, have now reverted to cash ISAs. Toisa funds can be transferred to another ISA for an improved rate.


• Cash ISAs in UK regulated banks are protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person per institution. For more details, see Secure Savings and Compensation.


• Rates listed here are correct to the date of publication or last edit (provided below).